The Fed Chair must acknowledge that free money has made asset prices unsustainably high

Gillian Tett in The FT 

This week financiers’ eyes have been firmly fixed on the Federal Reserve. No wonder. On Wednesday the US central bank raised rates at the most aggressive pace for 22 years, as Jay Powell, Fed chair, finally acknowledged the obvious: inflation is “much too high”. 

But as investors parse Powell’s words, they should spare a thought for a central bank on the other side of the world: the Reserve Bank of New Zealand. 

In recent years, this tiddler has often been an unlikely harbinger of bigger global trends. In the late 20th century, for instance, the RBNZ pioneered inflation targeting. More recently, it embraced climate reporting ahead of most peers. 

Last year, it started tightening policy before most counterparts. And this week it went further: its latest financial stability report warns of a “plausible” chance of a “disorderly” decline in house prices, as the era of free money ends. 

Unsurprisingly, the RBNZ also said it hopes to avoid a destabilising crash. But the key point is this: the Kiwi central bankers know they have an asset bubble on their hands, since property prices have jumped 45 per cent higher in the last two years and “are still estimated to be above sustainable levels”. This reflects both ultra-low rates and dismally bad domestic housing policies. 

And it is now telling the public and politicians that this bubble needs to deflate, hopefully smoothly. There is no longer a Kiwi “put” — or a central bank safety net to avoid price falls. 

If only the Fed would be as honest and direct. On Wednesday Powell tried to engage in some plain speaking, by telling the American people that inflation was creating “significant hardship” and that rates would need to rise “expeditiously” to crush this. He also declared “tremendous admiration” for his predecessor Paul Volcker, who hiked rates to tackle inflation five decades ago, even at the cost of a recession. 

However, what Powell did not do was discuss asset prices — let alone admit that these have recently been so inflated by cheap money that they are likely to fall as policy shifts. 

A central bank purist might argue that this omission simply reflects the nature of Powell’s mandate, which is to “promote maximum employment and stable prices for the American people”, as he said on Wednesday. In any case, evidence about the short-term risk of asset price falls is mixed. 

Yes, the S&P 500 has dipped into correction territory twice this year, with notable declines in tech stocks. However, the American stock indices actually rallied 3 per cent on Wednesday, after Powell struck a more dovish tone than expected by ruling out a 75 basis point rise at the next meeting. 

And there is no sign of any fall in American property prices right now. On the contrary, the Case-Shiller index of home prices is 34 per cent higher than it was two years ago, according to the most recent (February) data. 

However, it beggars belief that Powell could crush consumer price inflation while leaving asset prices intact. After all, one key factor that has raised these prices to elevated levels is that the Federal Reserve’s $9tn balance sheet almost doubled during the COVID-19 pandemic (and has expanded it nine-fold since 2008.) 

And, arguably, the most significant aspect of the Fed’s decision on Wednesday is not that 50bp rise in rates, but the fact that it pledged to start trimming its holdings of mortgages and treasuries by $47.5bn each month, starting in June — and accelerate this to a $90bn monthly reduction from September. 

According to calculations by Bank of America, this implies a $3tn balance sheet shrinkage (quantitative tightening, in other words) over the next three years. And it is highly unlikely that the impact of this is priced in. 

After all, QT on this scale has never occurred before, which means that neither Fed officials nor market analysts really know what to expect in advance. Or as Matt King, an analyst at Citibank, observes: “The reality is that tightening hasn’t really started yet.” 

Of course, some economists might argue that there is no point in the Fed spelling out this risk to asset prices now, given how this might hurt confidence. That would not make Powell popular with a White House that is facing a difficult election, Nor would it help him achieve his stated goal of a “soft” (or “softish”) economic landing, given that consumer sentiment has wobbled in recent months. 

But the reason why plain speaking is needed is that a dozen years of ultra-loose policy has left many investors (and households) addicted to free money, and acting as if this is permanent. Moreover, since the Fed has repeatedly rescued investors from a rapid asset price correction in recent years — most recently in 2020 — many investors have an innate assumption that there is a Fed “put”. 

So if Powell truly wants to emulate his hero Volcker, and take tough measures for long-term economic health, he should take a leaf from the Kiwi book, and tell the American public and politicians that many asset prices have been pumped unsustainably high by free money. 

That might not win him fans in Congress. But nobody ever thought it would be easy to deflate a multitrillion dollar asset price bubble. And the Fed has a better chance of doing this smoothly if it starts gently and early. Wednesday’s rally shows the consequences of staying silent.

Central banks were always political – so their ‘independence’ doesn’t mean much

The separation of monetary and fiscal policy serves the neoliberal status quo. It won’t survive the next crash writes Larry Elliott in The Guardian 

 

‘The Federal Reserve is coming under enormous pressure from Donald Trump to cut interest rates.’ Donald Trump with Jerome Powell, then his nominee for chairman of the Federal Reserve, Washington DC, November 2017. Photograph: Carlos Barría/Reuters


Independent central banks were once all the rage. Taking decisions over interest rates and handing them to technocrats was seen as a sensible way of preventing politicians from trying to buy votes with cheap money. They couldn’t be trusted to keep inflation under control, but central banks could.

And when the global economy came crashing down in the autumn of 2008, it was central banks that prevented another Great Depression. Interest rates were slashed and the electronic money taps were turned on with quantitative easing (QE). That, at least, is the way central banks tell the story.

An alternative narrative goes like this. Collectively, central banks failed to stop the biggest asset-price bubble in history from developing during the early 2000s. Instead of taking action to prevent a ruinous buildup of debt, they congratulated themselves on keeping inflation low.

Even when the storm broke, some institutions – most notably the European Central Bank (ECB) – were slow to act. And while the monetary stimulus provided by record-low interest rates and QE did arrest the slide into depression, the recovery was slow and patchy. The price of houses and shares soared, but wages flatlined.

A decade on from the 2008 crash, another financial crisis is brewing. The US central bank – the Federal Reserve – is coming under huge pressure from Donald Trump to cut interest rates and restart QE. The poor state of the German economy and the threat of deflation means that on Thursday the ECB will cut the already negative interest rate for bank deposits and announce the resumption of its QE programme.

But central banks are almost out of ammo. If cutting interest rates to zero or just above was insufficient to bring about the sort of sustained recovery seen after previous recessions, then it is not obvious why a couple of quarter-point cuts will make much difference now. Likewise, expecting a bit more QE to do anything other than give a fillip to shares on Wall Street and the City is the triumph of hope over experience.

There were alternatives to the response to the 2008 crisis. Governments could have changed the mix, placing more emphasis on fiscal measures – tax cuts and spending increases – than on monetary stimulus, and then seeking to make the two arms of policy work together. They could have taken advantage of low interest rates to borrow more for the public spending programmes that would have created jobs and demand in their economies. Finance ministries could have ensured that QE contributed to the long-term good of the economy – the environment, for example – if they had issued bonds and instructed central banks to buy them.

This sort of approach does, though, involve breaking one of the big taboos of the modern age: the belief that monetary and fiscal policy should be kept separate and that central banks should be allowed to operate free from political interference.

The consensus blossomed during the good times of the late 1990s and early 2000s, and survived the financial crisis of 2008 . But challenges from both the left and right, especially in the US, suggest that it won’t survive the next one. Trump says the Fed has damaged the economy by pushing up interest rates too quickly. Bernie Sanders says the US central bank has been captured by Wall Street. Both arguments are correct. It is a good thing that central bank independence is finally coming under scrutiny.

For a start, it has become clear that the notion of depoliticised central bankers is a myth. When he was governor of the Bank of England, Mervyn King lectured the government about the need for austerity while jealously guarding the right to set interest rates free from any political interference. Likewise, rarely does Mario Draghi, the outgoing president of the ECB, hold a press conference without urging eurozone countries to reduce budget deficits and embrace structural reform.

Central bankers have views and – perhaps unsurprisingly – they tend to be quite conservative ones. As the US economist Thomas Palley notes in a recent paper, central bank independence is a product of the neoliberal Chicago school of economics and aims to advance neoliberal interests. More specifically, workers like high employment because in those circumstances it is easier to bid up pay. Employers prefer higher unemployment because it keeps wages down and profits up. Central banks side with capital over labour because they accept the neoliberal idea that there is a point – the natural rate of unemployment – beyond which stimulating the economy merely leads to higher inflation. They are, Palley says, institutions “favoured by capital to guard against the danger that a democracy may choose economic policies capital dislikes”.

Until now, monetary policy has been deemed too important to be left to politicians. When the next crisis arrives it will become too political an issue to be left to unelected technocrats. If that crisis is to be tackled effectively, the age of independent central banks will have to come to an end.

Move over central bankers, your models are part of the problem

The new masters of the universe are struggling to understand what makes a modern economy tick and their actions could prove harmful.

Chris Giles in The Financial Times

Central bankers usurped the titans of Wall Street as the masters of the universe almost a decade ago. They rescued the global economy from the financial crisis, flooding the world with cheap money. They used their powers effectively to get banks lending again. Their actions raised asset prices, keeping business and consumer confidence up. Financial markets and populations hang on their words. But never have they been so vulnerable. 

As they gather in Washington for the annual meetings of the International Monetary Fund, there is a crisis of confidence in central banking. Their economic models are failing and there are doubts whether they understand the effects of interest rates and other monetary policies on the economy. 

In short, the new masters of the universe might not understand what makes a modern economy tick and their well-intentioned actions could prove harmful. 

While there have long been critics of the power of central bankers on the left and the right, such profound doubts have never been so present within their narrow world. In the words of billionaire investor Warren Buffett, they risk being the next ones to be found swimming naked when the tide goes out. 

The ability of central banks to resolve these questions does not just affect growth rates, but is fundamental to the health of the democracies of advanced economies, many of which have been assailed by populist uprisings. 

“If we can’t get inflation back up [trouble lies ahead]. We can’t have political stability without wage growth,” says Adam Posen, head of the Peterson Institute and formerly a central banker at the Bank of England. 

The root of the current insecurity around monetary policy is that in advanced economies — from Japan to the US — inflation is not behaving in the way economic models predicted. 

Deflation failed to materialise in the depths of the great recession of 2008-09 and now that the global economy is enjoying its broadest and strongest upswing since 2010, inflationary pressures are largely absent. Even as the unemployment rate across advanced economies has fallen from almost 9 per cent in 2009 to less than 6 per cent today, IMF figures this week show wage growth has been stuck hovering around annual increases of 2 per cent. The normal relationships in the labour market have broken down. 

Amid this forecasting nightmare, some frank talk is breaking out. Janet Yellen, chair of the US Federal Reserve and the world’s most important central banker, has been the most direct. “Our framework for understanding inflation dynamics could be mis-specified in some fundamental way,” she said last month. Her sentiments are spreading. 

For Mark Carney, governor of the BoE, global considerations “have made it more difficult for central banks to set policy in order to achieve their objectives”. Mario Draghi, president of the European Central Bank, is keeping the faith for now, but observes, “the ongoing economic expansion . . . has yet to translate sufficiently into stronger inflation dynamics”. 

Claudio Borio, chief economist of the Bank for International Settlements, which provides banking services to the world’s central banks, says: “If one is completely honest, it is hard to avoid the question: how much do we really know about the inflation process?” 

The details of macroeconomic models are fiendishly complicated, but at their heart is a relationship — called the Phillips curve — between the economic cycle and inflation. The cycle can be measured by unemployment, the rate of growth or other variables, and the model predicts that if the economy is running hot — if unemployment falls below a long-run sustainable level or if growth is persistently faster than its speed limit — inflation will rise. 

The models are augmented by a concept of inflation expectations, which keep inflation closer to a central bank’s target — usually 2 per cent — if the public trusts that central bankers will do whatever it takes to return inflation to that level after any temporary deviation. The holy grail for central bankers is to claim credibly that they have “anchored inflation expectations” at the target level. 

In the model, the most important factors that explain price movements are therefore the degree to which the economy has room to grow without inflation, termed “slack” or “the output gap”, and the public’s inflation expectations. 

The role of central banks in the model is to set the short-term interest rate. If a central bank sets its official interest rates low, people and companies will be encouraged to borrow more to spend and invest and discouraged from saving, boosting the economy in the short term. Higher interest rates cool demand. 

The first fundamental problem with the model is, as Mr Borio says, “the link between measures of domestic slack and inflation has proved rather weak and elusive for at least a couple of decades”. 

While Japan’s unemployment rate is now back down to the levels of the 1970s and 1980s boom, leaving little slack, inflation is barely above zero. In Britain, unemployment has almost halved since 2010, but wage growth has stuck resolutely at 2 per cent a year. 

But many economists and central bankers are wedded to the underlying theory, which is about 30 years old, and seek to tweak it to explain recent events rather than ditch it in favour of less orthodox ideas. Such nips and tucks are occurring all over the world, although the explanations differ. 

Ms Yellen has highlighted measurement issues in inflation and “idiosyncratic shifts in the prices of some items, such as the large decline in telecommunication service prices seen earlier in the year”. Similarly, the ECB is fond of a new definition — “super core inflation”, which strips out more items from the index and shows the bank performing better against its target than the headline measure. But few central bankers are happy with meeting targets only once they have moved the goalposts. 

A second explanation is that the level of unemployment that is consistent with stable inflation has fallen. In 2013, the BoE thought the UK economy could not withstand unemployment falling below 7 per cent before wages and inflation would pick up. It now thinks that rate is 4.5 per cent. On this reasoning, inflation has been low because there was more slack in the economy than they had thought. 

The problem with such explanations, as Daniel Tarullo, a Fed governor for eight years until April, notes, is that if central bankers keep changing their notion of sustainable unemployment levels “sound estimation and judgment are sometimes hard to differentiate from guesswork in attempting to see through transitory developments”. 

A third explanation is that central bankers have been so successful in anchoring inflation expectations, companies do not seek to raise prices any faster and workers do not ask for wage rises even when jobs are plentiful. 

Mr Draghi recently urged union pay bargainers to stop looking backward at inflation rates of the past when they negotiate wages, in a move that used to be unthinkable for a central banker. The problem with this explanation is both the self-serving reasoning and the fact that inflation expectations cannot be measured. 

“Over my time at the Fed, I came to worry that inflation expectations are bearing an awful lot of weight in monetary policy these days, considering the range and depth of unanswered questions about them,” says Mr Tarullo. 

The Bank of Japan, meanwhile, frets that companies are cutting employees’ hours and raising productivity rather than paying more, which is hampering its ability to push up inflation despite extremely low unemployment. 

If it was not bad enough that the link between the economic cycle and inflation has broken down, the second fundamental problem in central banking is that estimates of the neutral rate of interest — seen as the long-term rate of interest that balances people’s desire to save and invest with their desire to borrow and spend — appear to have fallen persistently across the world. 

The Fed’s central estimates of the real neutral interest rate has declined by nearly two-thirds in five years, from 2 per cent to 0.75 per cent. But the figures are again little more than guesswork. As Ms Yellen said, “[the neutral rate’s] value at any point in time cannot be estimated or projected with much precision”. 

Whether it is because ageing populations want to save more or because of a global “savings glut”, as former Fed chair Ben Bernanke said, low rates no longer have the same impact, limiting the effectiveness of the medicine central banks want to administer. 

Regardless of the terminology, the two problems combined suggest central bankers cannot easily determine whether their economies need stimulus or cooling and do not know whether their monetary tools are helping them do their job. And there is increasing concern, even expressed by Ms Yellen, that the underlying theoretical model might simply be rotten to the core and attempts to tweak it are futile. 

“Essentially you are setting policy on things you don’t know and can’t measure and then reasoning after the fact,” says Mr Tarullo. His core argument is that central banks maintain an absolute faith in the model with absolutely no evidence to support it. 

At a conference last month to celebrate the BoE’s 20 years of independence, Christina Romer, professor of economics at the University of California, Berkeley, urged central bankers to have a more open mind. 

New research is needed to question whether current thinking is deficient, she said, “and if such research suggests our ideas explaining how the economy works are wrong or need to change, then central bankers need to embrace those ideas”. 

The most aggressive critic of the consensus is Mr Borio of the BIS. He accuses central bankers of misunderstanding the drivers of inflation and their effects on the economy. His argument is that global forces of trade integration and technology are more convincing than concepts of domestic slack in explaining the absence of pricing power among companies and employees. 

He asks: “Is it reasonable to believe that the inflation process should have remained immune to the entry into the global economy of the former Soviet bloc and China and to the opening up of other emerging market economies?” 

His concern is that by keeping interest rates low, central bankers have no effect on inflation or the economy other than to increase the level of debt. The result is that it will be harder “to raise interest rates without causing economic damage, owing to the large debts and distortions in the real economy that the financial cycle creates”. 

It is not a popular view, but it is no longer dismissed out of hand. Ms Yellen justified her stance on continuing to raise interest rates gradually in the face of persistently low inflation by appealing to concerns about debt. 

“Persistently easy monetary policy might also eventually lead to increased leverage and other developments, with adverse implications for financial stability,” she said. 

With central bankers credited for keeping the economic show on the road over the past decade, it will come as a shock to many to hear how little confidence they have in their models, their policies and their tools. 

One question posed by Richard Barwell, a senior economist at BNP Paribas, is whether they should let on about how little they know. “It’s rather like Daddy is driving the car down a hill, turning round to the family and saying, ‘I’m not sure the brakes work, but trust me anyway’,” he says. 

For now, the public still trust the women and men who work in the marbled halls of central banks around the world. But that confidence is fragile. Central bankers might have been the masters of the universe of the past decade, but they know well what happened to the previous holders of that title.

Another recession is coming - the only question is how bad

Jeremy Warner in The Telegraph


According to the late, and great, American economist Rudi Dornbusch “none of the US expansions of the past 40 years died in bed of old age; every one was murdered by the Federal Reserve”. What he meant by this was that all US business cycles are brought to an end not by natural causes but by the actions of the Fed in raising interest rates. The art of the central banker is to take away the punch bowl before the party gets going, but few succeed; invariably they leave it too late, so that when they do apply the brakes, the economy crashes.


A powerful US senator is proposing the Federal Reserve, pictured, is stripped of the majority of its regulatory powers


With the Fed’s Open Market Committee again hinting at a rate rise by the end of the year, are not policymakers in danger of repeating the same mistake? I believe they are – that recession risk in the US and in Britain is substantially underestimated both by policymakers and the markets. Consider the facts. The current expansion may not feel like a boom, and in many respects it isn’t. In the UK, working age disposable income has still to recover to pre-crisis levels.

Yet in both Britain and the US, the economic expansion is already a long one by historic standards. Indeed, in the US it is one of the longest ever, as defined by the National Bureau of Economic Research, proud keeper of the record on American business cycles – a full 76 months, against the 58.4 month average for the 11 post war cycles identified. Only three of these cycles have been longer.

No recession is ever predicted by official forecasting; it would be an admission of failure if it was, for the whole purpose of economic policy making is to keep things just right – not too hot and not too cold. Ultimately, the policymakers always fail. Gordon Brown, the last UK prime minister, preposterously boasted that he had abolished boom and bust. Alan Greenspan, former Fed chairman, likewise believed he could defy the gods. Both were in for a rude awakening, having failed to notice the mega-boom their policies helped create in financial services.

With this searing experience to learn from, the present generation of economic decision makers tends to be less hubristic in aim, yet even George Osborne, the Chancellor, is relying on extended growth way beyond the normal parameters of a typical business cycle to meet his target of a budget surplus by 2019/20.

As it is, there is little chance of this target being met. It will be broken on the anvil of events. Already there are worrying signs of a slowdown in the UK, with both construction and manufacturing contracting in the last quarter. Lead indicators published by the OECD, a relatively accurate predictor of past recessions, point unambiguously to a pronounced UK slowdown and to a loss of growth momentum in the US.

In Europe, things are still so bad that the European Central Bank is considering even more monetary accommodation on top of the quantitative easing and negative interest rates already applied. Likewise China, where far from raising rates, they are cutting them in an attempt to head off a hard landing which in all probability is already happening. The China Iron & Steel Association has warned of an “unprecedented” slump in steel demand and prices as China attempts to transition from investment to consumption led growth.

Central banks normally act in raising rates when the economy is booming. The curiosity of this particular expansion is that for advanced economies at least, it seems barely to have begun. If there has been a boom, you’ll be forgiven for not having been aware of it. So why is the Fed thinking of acting?

There are two reasons. First, the Fed worries that once the effect of the sharp drop in oil prices falls out of the equation, inflation will come surging back, and it wants to dampen things before this happens. The other is that it simply yearns, like the rest of us, for a degree of normality in interest rates. If it can’t do it now, with the economy growing, when will it ever?

Regrettably, it may already be too late. After seven years of “unconventional monetary policy”, the world economy is once more drowning in easy credit, with few of the underlying causes of the global financial crisis even remotely addressed.
Excessive leverage and investment risk taking is again the order of the day, not so much in Britain, but certainly in the US and previously booming emerging market economies. One small interest rate rise may be all it takes to plunge the world back into some kind of mild recession. Yet to double up, as the Bank of England’s chief economist, Andy Haldane, recently suggested as a possible answer to renewed weakness in the global economy, and pile yet further “unconventional” policy on top, risks an even bigger bust further down the line. The choice, I’m afraid, is between the economy catching a cold now, or full-blown pneumonia later.

Paralysed by political cowardice, advanced economy governments have become far too reliant on monetary voodoo to support demand, leaving central banks with an almost impossible task. Supply-side measures to turbo-charge investment, including if necessary additional public infrastructure spending, must be brought forward as a matter of urgency.

Emerging market rout threatens wider global economy

The $9 trillion (£5.8 trillion) accumulation of foreign bonds by the rising powers of Asia, Latin America and the emerging world risks going into reverse as one country after another is forced to liquidate holdings to shore up its currency, threatening to inflict a credit shock on the global economy.

Fears of Fed tightening have pushed borrowing costs worldwide to levels that could threaten global recovery Photo: AFP

By Ambrose Evans-Pritchard in The Telegraph

8:38PM BST 22 Aug 2013

India’s rupee and Turkey’s lira both crashed to record lows on Thursday following the US Federal Reserve releasing minutes which signalled a wind-down of quantitative easing as soon as next month.

Dilma Rousseff, Brazil’s president, held an emergency meeting on Thursday with her top economic officials to halt the real’s slide after it hit a five-year low against the dollar. The central bank chief, Alexandre Tombini, cancelled his trip to the Fed’s Jackson Hole conclave in order “to monitor market activity” amid reports Brazil is preparing direct intervention to stem capital flight.

The country has so far relied on futures contracts to defend the real – disguising the erosion of Brazil’s $374bn reserves – but this has failed to deter speculators. “They are moving currency intervention off balance sheet, but the net position is deteriorating all the time,” said Danske Bank’s Lars Christensen.

A string of countries have been burning foreign reserves to defend exchange rates, with holdings down 8pc in Ecuador, 6pc in Kazakhstan and Kuwait, and 5.5pc in Indonesia in July alone. Turkey’s reserves have dropped 15pc this year.

“Emerging markets are in the eye of the storm,” said Stephen Jen at SLJ Macro Partners. “Their currencies are in grave danger. These things always overshoot.” 

It was Fed tightening and a rising dollar that set off Latin America’s crisis in the early 1980s and East Asia’s crisis in the mid-1990s. Both episodes were contained, though not easily.

Emerging markets have stronger shock absorbers today and largely borrow in their own currencies, making them less vulnerable to a dollar squeeze. However, they now make up half the world economy and are big enough to set off a crisis in the West.

Fears of Fed tightening have pushed borrowing costs worldwide to levels that could threaten global recovery. Yields on 10-year bonds jumped 47 basis points to 12.29pc in Brazil on Thursday, 33 points to 9.72pc in Turkey, and 12 points to 8.4pc in South Africa.

There had been hopes that the Fed might delay its tapering of bond purchases, chastened by the jump in long-term rates in the US itself. Ten-year US yields – the world’s benchmark price of money – have soared from 1.6pc to 2.9pc since early May.

Hans Redeker from Morgan Stanley said a “negative feedback loop” is taking hold as emerging markets are forced to impose austerity and sell reserves to shore up their currencies, the exact opposite of what happened over the past decade as they built up a vast war chest of US and European bonds.

The effect of the reserve build-up by China and others was to compress global bond yields, leading to property bubbles and equity booms in the West. The reversal of this process could be painful.

“China sold $20bn of US Treasuries in June and others are doing the same thing. We think this is driving up US yields, and German yields are rising even faster,” said Mr Redeker. “This has major implications for the world. The US may be strong to enough to withstand higher rates, but we are not sure about Europe. Our worry is that a sell-off in reserves may push rates to levels that are unjustified for the global economy as a whole, if it has not happened already.”

Sovereign bond strategist Nicolas Spiro said India is “caught between the Scylla of faltering growth and the Charybdis of currency depreciation” as hostile markets start to pick off any country with a large current account deficit. He said India’s central bank is playing with fire by reversing its tightening measures to fend off recession. It has instead set off a full-blown currency crisis that is crippling for companies with dollar debts.

India is not alone. A string of countries across the world are grappling with variants of the same problem, forced to pick their poison.

Regulatory Capture - The Bank of England knew of LIBOR rigging but did nothing

Ben Chu in The Independent

Regulators on both sides of the Atlantic failed to act on clear warnings that the Libor interest rate was being falsely reported by banks during the financial crisis, it emerged last night. 

A cache of documents released yesterday by the New York Federal Reserve showed that US officials had evidence from April 2008 that Barclays was knowingly posting false reports about the rate at which it could borrow in order to assuage market concerns about its solvency.

An unnamed Barclays employee told a New York Fed analyst, Fabiola Ravazzolo, on 11 April 2008: "So we know that we're not posting, um, an honest Libor." He said Barclays started under-reporting Libor because graphs showing the relatively high rates at which the bank had to borrow attracted "unwanted attention" and the "share price went down".

The verbatim note of the call released by the Fed represents the starkest evidence yet that Libor-fiddling was discussed in high regulatory circles years before Barclays' recent £290m fine.

The New York Fed said that, immediately after the call, Ms Ravazzolo informed her superiors of the information, who then passed on her concerns to Tim Geithner, who was head of the New York Fed at the time. Mr Geithner investigated and drew up a six-point proposal for ensuring the integrity of Libor which he presented to the British Bankers Association, which is responsible for producing the Libor rate daily.

Mr Geithner, who is now US Treasury Secretary, also forwarded the six-point plan to the Governor of the Bank of England, Sir Mervyn King. The Bank pointed out last night that there was no evidence in the Geithner letter of banks actually making false submissions – although then note did allude to "incentives to misreport".

It was unclear last night whether Mr Geithner informed Sir Mervyn about the testimony of the Barclays employee who said that the bank was being dishonest in its submissions.

If it turned out that he did, that would be highly damaging for the Bank since it has always claimed that it never saw or heard any evidence that private banks were deliberately making false reports about their borrowing costs. Sir Mervyn is due to be questioned by the House of Commons Treasury Select Committee next Tuesday, where MPs are likely to put this question to the Governor.

The Bank's Deputy Governor, Paul Tucker, went before the Treasury committee last week to answer allegations that he had put pressure on Barclays to misreport its borrowing rates in 2008 while attempting to promote financial stability. Mr Tucker denied that he had done so and said he only found out that Barclays had been deliberately submitting dishonest Libor submissions recently.

The New York Fed released its cache of documents in response to a request from the chairman of Congress's Committee on Financial Services on Oversight and Investigation, Randy Neugebauer, who has been investigating how much US regulators knew about the rate-fixing scandal, in which 11 other banks around the world have been implicated.

A separate email released by the Bank of England yesterday shows that Mr Tucker forwarded the Geithner email to Angela Knight, the former chief executive of the British Bankers Association. She responded saying that "changes had been made to incorporate the views of the Fed".

While the BBA is understood to have acted on two of Mr Geithner's proposals, the other four were not adopted.

Before hearing from Sir Mervyn on Tuesday, the Treasury Select Committee is set to take evidence on Monday afternoon from Jerry del Missier, the former chief operating officer at Barclays, who gave the green light for traders to submit false Libor submissions during the crisis. He will be asked about whether he thought the order to do so had come down from the Bank of England.

Last month Barclays was fined £290m for rigging Libor between 2005 and 2008. The regulators found that Barclays traders had initially submitted false reports to make profits for its traders, but subsequently to allay concerns about the bank's health. Barclays' chief executive Bob Diamond resigned on 3 July. The Libor rate is used to fix the cost of borrowing on mortgages, loans and derivatives worth more than $450 trillion (£288 trillion) globally.

The missed warnings: ‘So we know that we’re not posting, um an honest Libor

One document released yesterday by the Fed detailed a conversation between staffer Fabiola Ravazzolo and an unnamed Barclays employee in April 2008, including the following edited extract:

Fabiola Ravazzolo: And, and why do you think that there is this, this discrepancy? Is it because banks maybe they are not reporting what they should or is it um…

Barclays employee: Well, let's, let's put it like this and I'm gonna be really frank and honest with you.

FR: No that's why I am asking you [laughter] you know, yeah [inaudible] [laughter]

BE: You know, you know we, we went through a period where we were putting in where we really thought we would be able to borrow cash in the interbank market and it was above where everyone else was publishing rates.

FR: Mm hmm.

BE: And the next thing we knew, there was um, an article in the Financial Times, charting our LIBOR contributions... and inferring that this meant that we had a problem... and um, our share price went down... So it's never supposed to be the prerogative of a, a money market dealer to affect their company share value.

FR: Okay.

BE: And so we just fit in with the rest of the crowd, if you like... So, we know that we're not posting um, an honest LIBOR. And yet and yet we are doing it, because, um, if we didn't do it it draws, um, unwanted attention on ourselves.

FR: Okay, I got you then.

BE: And at a time when the market is so um, gossipy... it was not a useful thing for us as an organization.