For the dollar-crash pundits, one of the key drivers of the doomsday scenario where the US is suddenly cut off from the torrent of foreign capital necessary to fund it's negative savings economy (and a trillion dollar war habit) is a rather nebulously specified "rise in protectionism."
As every student of orthodox economics is taught, and the public debate on trade has accepted as fait accompli since what feels like the Reagan era, the goodness of free trade is as pure a thing as there is to be explained in economics. As the story goes, the principle of comparative advantage enlarges the economic pie for everybody. Furthermore the reduction of frictions and barriers to trade are touchstones of a modern, efficient, and open society.
However, a lot of economics is about the frictions, the sand in the gears, of theoretical purity. Ronald Coase, one of m*'s favorite old time economists, won the Noble prize for examining some of those frictions, transaction costs to be specific, and theorizing that enterprises organize themselves into corporations in order to minimize those transaction costs.
When it comes to the sacred cow of free trade however, the frictions created by globalization - the very real and serious impact on the economic well being of ordinary people, are the inconvenient truths rarely discussed openly by serious members of the profession, with some exceptions. As long as the pie is expanding, it is impolitic to ask whether and for whom the pie is shifting as well. Inequality is not a subject economics handles well, and this ideal, utterly inimicable to the economic well being of the US middle class, has somehow become the law of the land in economic thought.
Yet a strong case can be made that for adherence to an economic ideal, the manufacturing base in the US and a sense of purpose and security for a large mid-section of the population has been sacrificed. No doubt a young Chinese factory worker's life in an industrial complex resembling a city is better in many respects than the deep rural poverty that would have preceded it. And m* can well appreciate the benefits of "everyday low prices" in poor rural sections of the US as well. But those kinds of benefits do absolutely nothing to create investment or better long run prospects for our people, and our democracy.
What is surprising to m* is how little complaint there has been from the manufacturing regions of the country, as one industry after another has been packed up and shipped off overseas. Distracted by fighting the war on terror, and fooled about their prospects by the (now departed) housing bubble, the US's losers in globalization have been mostly silent. Now they are waking up.
The extraordinary article on the WSJ's front page today, Republicans Grow Skeptical on Free Trade , signals a dramatic shift in opinion that brings the Red State voter in close alignment with many Blue State voters, and portends significant pressure on the unfettered free trade the owners of capital have enjoyed (with extraordinary sized profits as a share of GDP to show for it) while real wages for the average US worker have steadily declined. While pockets of dissatisfaction have surfaced before, a two to one margin of Republican voters now believe free trade is bad for the economy.
To be clear, m* is all for fair and open trade, and abhors tariffs, subsidies, and import quotas on principle. However, the system now in place, beginning with China's accession to the WTO in 2001, has been anything but fair and open. Heavily lobbied for by corporations seeking access to a vast and dirt-cheap labor pool as well as a billion person market, the accession allowing China to maintain a closed capital account and an inconvertible currency was a grave error of short-term profit seeking behavior. The 2001 agreement focused almost exclusively on microeconomic issues, market structures, and reducing trade controls, many of which, six years later, appear to have failed. Yet the macroeconomic "global imbalances" that have resulted from an unlevel monetary playing field, including massive trade deficits, distorted risk premiums, over-investment and consumption globally, and an explosion of debt in developed nations, will have serious consequences on US standards of living as the inevitable (and thoroughly underway) inflation and debasement of the dollar gather pace.
For the moralists' case, the Red's are coming around.
Thursday, October 4, 2007
Monday, September 24, 2007
Conundrum, undone
Now that markets have had a few trading days to digest the Fed's surprisingly aggressive move on rates, (and dropped into bit of a lull actually), and readers have maybe wondered about “turning points” and “watershed moments” for one thing or another, m* thought it would be good to share the one observation that in m*’s view really deserves attention.
It is that the bond market has finally woken up to all the reasons why it is overpriced.
Experience during the "benign inflationary environment," of the Greenspan era, using the usual, mmm…, interesting price indices of course, was that lower rates on the front end actually supported bond purchases on the back end. So while rate cuts might lead to a steeper yield curve, they did not lead to higher long term rates.
At the same time, and more vexing to just about everyone, higher rates on the front end did not translate into higher bond yields on the long end either, leading to flattish yield curves in most major economies. Nor did dramatic fluctuations in fiscal position seem to have an influence as they once did.
It was as though the long end had become entirely divorced from actions at the short end, fiscal positions, trade deficits, and very strong economic growth globally, thus defying a whole set of accepted economic principles. This “conundrum” has become part of the global financial landscape as a number of happy circumstances in price measures and capital flows have conspired over the last decade to hold inflationary expectations (or just the expression of them in the bond market) in check.
Globalization meant that
Globalization also meant that
In short, the risk premium, (where long term lenders demand some additional yield for assuming inflation risk) was squeezed out of bond yields.
However, that appears to be no longer. And as long anticipated, (if you’ve known m* a while), it is weakness in the dollar that is finally changing the tone of the interest rate picture.
While the global imbalances crowd has long been focused on the possibility for an abrupt spike in rates due to a cessation of purchases of bonds by the Central Banks of the nation’s major Asian trading partners, the catalyst for such a change has never been clear. Trade frictions, political crisis, or in the longer term, a greater demand for capital at home have all been possible culprits.
However the potential for the weaker dollar, to this point reflecting shifting allocations by Central Bank reserve managers (and US retail investors!), to augment the inflation concerns already afoot globally is now reaching a serious level. Remember that prior to the summer credit crisis, both the Fed and the ECB postures were most concerned with inflation pressures, while currently the Bank of China is actively and utterly ineffectively engaged in a battle with domestic inflation of its own. Expect bonds and the dollar to trade together from here on out.
Wednesday, September 19, 2007
The Circle: Chapter 1
Readers of the last post concerning former Chairman Greenspan have been in touch. Concerned that m* has somehow lost an earlier grasp of things, or is finally going soft in the head, several have pointed out that the temperature of the water in the pot that the USD based financial system finds itself in is starting to climb decisively. The advances in gold, the Hang Seng, and the hard currencies over the last three days are loud testament to the radical and relentless pressure on the value of the world's major reserve currency now given fresh impetus by the Fed's recent rate cut decision.
Where to begin? First, consider the excellent essay and book review of Greenspan's "The Age of Turbulence" in the WSJ by James Grant, of the eponymous Grant's Interest Rate Observer - a first class newsletter in style, information, and intelligence. Mr. Grant concisely deflates much of the irrational exuberance in the Chairman's commonly accepted legacy and offers a far weirder and more concerning picture of a man and a set of policies perhaps less sophisticated than we may have presumed. He writes:
"Sooner or later, the dollar will lose its luster and finally its value, as paper currencies always do. Striving to understand why people trusted it in the first place, historians will naturally reach for the memoirs of the foremost central banker of his day. But Mr. Greenspan's "The Age of Turbulence" will leave them just as confused as they ever were...."
"The fantastic irony of Mr. Greenspan's career path -- from gold-standard libertarian to federal interest-rate fixer -- seems hardly to have registered on Mr. Greenspan himself..."
"Having watched his mentor, Arthur Burns, struggle with the chairmanship, Mr. Greenspan notes, "it did not seem like a job I felt equipped to do; setting interest rates for an entire economy seemed to involve so much more than I knew."
Mr. Grant adds, "A deeper kind of libertarian might have added: 'Maybe nobody can know enough to set interest rates for an entire economy.' "
Mr. Grant's piece is a highly disturbing visit to a rare distortion free zone (think bubble vision) and m* highly recommends reading the entire essay.
One of the most confusing aspects of the Greenspan legacy, no less confusing even to "the Maestro" himself has been the so-called interest rate conundrum. If money has been too cheap and credit has been too plentiful, where are the wage and price inflation pressures and concomitant higher long term interest rates elementary economics would expect?
Mr. Greenspan initially ascribed the lack of price pressures to increased productivity, (a presumed permanent increase actually) brought on by, yes, that new fangled thing known as the internet.
Later, he and others caught on to the impact of globalization, a catch all for the productivity improvements (in a statistical sense) gained by beaming capital and knowhow (and environmentally and fiscally unencumbered means of production) to one billion new job aspirants in recently opened and underdeveloped countries for the manufacture of goods for export back to developed nations' markets.
With few domestic liquid assets available to them, the exporters' central banks have recycled their unprecedented trade surpluses back into the developed nations' financial markets, especially the government securities that set the domestic market price for borrowing (particularly mortgage borrowing) thereby sustaining a virtuous circle of low interest rates and import consumption and leading to a chicken and egg debate between "savings glut," a now official term, and "credit bubble."
The "savings glut" has become the socially acceptable explanation (as it avoids any taint of an extended disequilibrium and the messy unraveling such situations inevitably entail) and its proponents frequently thrive as successful sell-side economists, macroeconomic research directors, and even future Federal Reserve Chairmen.
An especially abstract and sadly for m* fascinating bunch of monetary economists (mostly) attribute the reduced risk premiums and stable inflation expectations to the stellar central banking of the last several years.
"The change in the behaviour of inflation over the last few decades cannot be explained at least in any great degree by changes in globalisation... By far the main thing is how central banks have behaved in terms of providing money growth and setting interest rates," says John Taylor, an influential monetary economist at Stanford, as quoted by Krishna Guha in the FT recently.
Ali G, John Taylor is in the Green room.
The "credit bubble" has become the touchstone for "the moralists," of which m* confesses to knowing a few, and rests its credulity on the mountain of counterfactual evidence for the rosy explanation offered by the other two, as so succinctly cataloged by Mr. Grant above.
Kenneth Rogoff, Harvard economics professor, explains this conundrum with a subtlety that has been lost on most observers (and been a struggle to articulate for m* quite frankly) with his observation that China, far from being a blanket source of deflationary pressure, has in fact been changing relative prices. "Fed treads a fine line between perils" byKrishna Guha, FT What this means is that one can accept certain facts of the "savings glut" argument without succumbing to the entire (somewhat common-sense defying to m*) explanation of why it should continue.
Unfortunately, Rogoff's insight comes too late to prevent the Greenspan Fed's ultra-stimulative policy error of 2003-4 and the undeniable bubbly aftermath in credit and housing markets today.
Where to begin? First, consider the excellent essay and book review of Greenspan's "The Age of Turbulence" in the WSJ by James Grant, of the eponymous Grant's Interest Rate Observer - a first class newsletter in style, information, and intelligence. Mr. Grant concisely deflates much of the irrational exuberance in the Chairman's commonly accepted legacy and offers a far weirder and more concerning picture of a man and a set of policies perhaps less sophisticated than we may have presumed. He writes:
"Sooner or later, the dollar will lose its luster and finally its value, as paper currencies always do. Striving to understand why people trusted it in the first place, historians will naturally reach for the memoirs of the foremost central banker of his day. But Mr. Greenspan's "The Age of Turbulence" will leave them just as confused as they ever were...."
"The fantastic irony of Mr. Greenspan's career path -- from gold-standard libertarian to federal interest-rate fixer -- seems hardly to have registered on Mr. Greenspan himself..."
"Having watched his mentor, Arthur Burns, struggle with the chairmanship, Mr. Greenspan notes, "it did not seem like a job I felt equipped to do; setting interest rates for an entire economy seemed to involve so much more than I knew."
Mr. Grant adds, "A deeper kind of libertarian might have added: 'Maybe nobody can know enough to set interest rates for an entire economy.' "
Mr. Grant's piece is a highly disturbing visit to a rare distortion free zone (think bubble vision) and m* highly recommends reading the entire essay.
One of the most confusing aspects of the Greenspan legacy, no less confusing even to "the Maestro" himself has been the so-called interest rate conundrum. If money has been too cheap and credit has been too plentiful, where are the wage and price inflation pressures and concomitant higher long term interest rates elementary economics would expect?
Mr. Greenspan initially ascribed the lack of price pressures to increased productivity, (a presumed permanent increase actually) brought on by, yes, that new fangled thing known as the internet.
Later, he and others caught on to the impact of globalization, a catch all for the productivity improvements (in a statistical sense) gained by beaming capital and knowhow (and environmentally and fiscally unencumbered means of production) to one billion new job aspirants in recently opened and underdeveloped countries for the manufacture of goods for export back to developed nations' markets.
With few domestic liquid assets available to them, the exporters' central banks have recycled their unprecedented trade surpluses back into the developed nations' financial markets, especially the government securities that set the domestic market price for borrowing (particularly mortgage borrowing) thereby sustaining a virtuous circle of low interest rates and import consumption and leading to a chicken and egg debate between "savings glut," a now official term, and "credit bubble."
The "savings glut" has become the socially acceptable explanation (as it avoids any taint of an extended disequilibrium and the messy unraveling such situations inevitably entail) and its proponents frequently thrive as successful sell-side economists, macroeconomic research directors, and even future Federal Reserve Chairmen.
An especially abstract and sadly for m* fascinating bunch of monetary economists (mostly) attribute the reduced risk premiums and stable inflation expectations to the stellar central banking of the last several years.
"The change in the behaviour of inflation over the last few decades cannot be explained at least in any great degree by changes in globalisation... By far the main thing is how central banks have behaved in terms of providing money growth and setting interest rates," says John Taylor, an influential monetary economist at Stanford, as quoted by Krishna Guha in the FT recently.
Ali G, John Taylor is in the Green room.
The "credit bubble" has become the touchstone for "the moralists," of which m* confesses to knowing a few, and rests its credulity on the mountain of counterfactual evidence for the rosy explanation offered by the other two, as so succinctly cataloged by Mr. Grant above.
Kenneth Rogoff, Harvard economics professor, explains this conundrum with a subtlety that has been lost on most observers (and been a struggle to articulate for m* quite frankly) with his observation that China, far from being a blanket source of deflationary pressure, has in fact been changing relative prices. "Fed treads a fine line between perils" byKrishna Guha, FT What this means is that one can accept certain facts of the "savings glut" argument without succumbing to the entire (somewhat common-sense defying to m*) explanation of why it should continue.
Unfortunately, Rogoff's insight comes too late to prevent the Greenspan Fed's ultra-stimulative policy error of 2003-4 and the undeniable bubbly aftermath in credit and housing markets today.
Put, on.
It has been a one-two punch for moral hazard this week as the UK Treasury pressured the BOE into backstopping the reckless business practice of the media savvy managers of a third tier UK mortgage lender (a deposit taking hedge fund in any analysis) and the Bernanke Fed, after much ado about nothing socialized the equity markets with a put very generously struck at all time highs.
Global strategists are now calling for the mother of all rallies into next year as the rate cycle turns and growth projections for next year go from weighting recession probabilities to discounting that altogether more equity friendly concept "the mid-cycle slow down" whatever that is. US markets responded appropriately and Asian markets hyper-appropriately, while the dollar made new lows against most alternatives. Moral hazard indeed.
Whatever one calls it, the concept most on m*'s mind is not growth or hazard so much as store-of-value. As a long term dollar bear, m* has been living with a workable definition in a relative sense but the cave-in this week, though hardly surprising, is an eye-opening step towards the precipice. m* is forming the conviction, at something deeper than an intellectual level finally, that the idea in an absolute sense can not exist in our current (fiat) money world.
Comments?
Global strategists are now calling for the mother of all rallies into next year as the rate cycle turns and growth projections for next year go from weighting recession probabilities to discounting that altogether more equity friendly concept "the mid-cycle slow down" whatever that is. US markets responded appropriately and Asian markets hyper-appropriately, while the dollar made new lows against most alternatives. Moral hazard indeed.
Whatever one calls it, the concept most on m*'s mind is not growth or hazard so much as store-of-value. As a long term dollar bear, m* has been living with a workable definition in a relative sense but the cave-in this week, though hardly surprising, is an eye-opening step towards the precipice. m* is forming the conviction, at something deeper than an intellectual level finally, that the idea in an absolute sense can not exist in our current (fiat) money world.
Comments?
Tuesday, September 18, 2007
Begging off
Between the Fed meeting and the Northern Rock m* readers have plenty of current events macroeconomic-wise to entertain themselves with for another day or two. Rest assured m* is working on some bigger picture ideas, well the main one or two really, in the background. Meanwhile, m*'s schedule and inbox are a bit tight at the moment and getting more-so. So, with all due apologies, it will be another day before the next post.
Sunday, September 16, 2007
Musical Chairman
Like his old boss, former President William Clinton, former Fed Chairman Alan Greenspan knows his way around a tune, both men sharing a well known love for jazz and playing the saxophone. Lately the former Chairman has been demonstrating a related talent for which he is also known, picking up a new tune when the music changes.
With his new book out in the US on Monday (m* readers in NYC can see the Chairman at the Union Square Barnes & Noble at 7pm) and front page appearances in the FT and the WSJ over the weekend, Greenspan has adapted to the new reality of the global credit environment he personally did much to foster rather well.
Speaking to the FT, Greenspan admits the housing market was in a bubble and that home price declines are likely to surprise to the downside. He also compared the yield pickup of asset-backed structured securities over treasuries to cocaine and the current commercial paper crunch to the '80's savings and loan "disaster".
As the recently departed Chairman after nineteen years of the institution charged with overseeing the health of the nation's banking system, price stability, and the path of economic progress, m* naturally wonders when exactly the Chairman came around to these conclusions?
Greenspan makes an odd celebrity. There is his age, beyond easy figuring but well into the wise old man category, the easily caricatured egghead visage with small eyes appearing behind enormous glasses, and that monotone warbling of un-intelligible but clearly highly intelligent verbiage. And he is an economist after all.
Bubble vision pumped him up of course, even while they made fun of his pending appearances with superhero antics and pre-game-show style briefcase analysis. But Greenspan more than anyone contributed to their mutual success, promoting and sustaining a bull market state of mind and an equity culture that swept the globe during his tenure.
Chairman Greenspan held the scepter of power among economic seers across nearly two decades and three presidential administrations, with a Chance the gardener-like talent for evading criticism and responsibility, while cultivating a public acceptance of the mystery of his wisdom and that of his institution.
Greenspan has always been the court's jester, adapting his performance to stay in the graces of whichever court is currently in power, as when he abandoned the successful fiscal conservatism of the Clinton/Rubin era for the budget busting Bush tax breaks for the wealthy, or filed away "Gold and Economic Freedom" to later preside over a succession of asset bubbles fueled by too cheap money and lax oversight.
However the unraveling of his decisions and their long term impact on savers and the purchasing power of the currency brings to mind another image from film, that of the powerful wizard revealed to be just a fallible man behind a curtain with a distortion microphone and a sputtering smoke machine, his omnipotence an illusion. But ever the showman, Greenspan manages to somehow stay in the public consciousness long enough to sell a few books for his publisher.
It must have been a light weekend on the fashion-news front as the WSJ’s Weekend Edition led with what was technically a Greenspan "book review," making sure to tell us they did not speak to the Chairman but rather, almost blog-like, “bought a copy at a bookstore in the New York area.” Perhaps the new owner at the Journal was not happy at paying the Chairman’s speaking fee. Over at Pearson however, where they’ll no doubt be waiting for the paperback, someone got him on the horn and the quotes are juicy.
Thursday, September 13, 2007
Message from Mervyn
Yesterday, the argument for rate cuts to save the US from impending recessionary disaster of an unspecified nature was aired by it's most learned and esteemed advocate, Martin Feldstein, who repeated his narrowcast doom and gloom speech from the recent Jackson Hole conference in the mass market pages of the WSJ.
m* strongly disagreed with this view and held out the example of BOE's Mervyn King as a counterweight to the luminaries calling for easing. In typical fashion, King's voice during this period has thus far been conspicuous by it's absence, until today when King broke the silence with his first comments weeks into the current crisis in the money markets and structured debt markets. In a statement prepared for regularly scheduled testimony to the Treasury next week, King sends an eloquent, reasoned message to the markets about the hazards of short term, emotionally driven thinking and the responsibility of a central banker. The short of it is captured by headline-of-the-day award winner and frequent source Macro Man with "No Soup for You!"
TURMOIL IN FINANCIAL MARKETS: WHAT CAN CENTRAL BANKS DO?
Paper submitted to the Treasury Committee
Mervyn King, Governor of the Bank of England
The recent turmoil in financial markets has increased uncertainty in the world economy.
Problems that surfaced first in the US sub-prime mortgage market are now visible more
widely. All those involved, whether banks, other financial institutions, regulators or
central banks, need to analyse carefully the causes of the recent turmoil and think through
the long-term consequences of any actions if they are to respond appropriately.
So in this note I shall try to answer two questions. First, what are the immediate causes
of the recent turmoil and what are its implications? Second, what can and should central
banks do to alleviate the problems? In due course we shall all have time for a more
detailed examination of this episode and the lessons to be learned from it.
1. What are the immediate causes of the recent turmoil and what are its implications?
Since the beginning of August, there have been sharp movements in financial markets:
prices of loans, and assets backed by loans, have fallen; prices of government securities
have risen; and interest rates on inter-bank lending have risen.
Rising default rates on sub-prime mortgages in the United States were the trigger for the
recent financial market turmoil. It is important, though, to put recent events in
perspective. The world economy has been strong for the past five years. Our own
economy has been growing at a steady rate for a considerable period. There are major
problems in the US housing market to which the authorities there are responding with
both macro and micro measures. But the losses from defaults so far remain small relative
to the capital of the banking system.
None of this is meant to say we should be complacent. But the source of the problems
lies not in the state of the world economy, but in a mis-pricing of risk in the financial
system. And it is on that set of issues that we need to focus to determine the remedies,
both short-term to address the current problems and long-term to prevent a recurrence.
Why have developments in one part of the US mortgage market proved so important for a
wide range of financial markets? Sub-prime mortgages are one type of loan that banks
have parcelled together into securities backed by the cash flows from those loans – a
process known as securitisation. Those securities have been sold by banks to investors.
They have also been sold to investment vehicles, many of which have been established
by the banks themselves. Many of these vehicles have financed their purchases by
issuing short-term commercial paper.
Securitisation of loans has separated the information held by loan originators from those
exposed to the risk of default – investors in asset-backed securities or commercial paper.
The unexpected losses sustained on assets backed by US sub-prime mortgages have
highlighted the potential costs to investors of uncertainty about the types of loans
underlying the assets they purchase. So for the time being the markets in these
instruments have either closed or become very illiquid. Vehicles financed by short-term
commercial paper are holding assets which can no longer be traded in liquid markets.
They now find that they have borrowed short to lend long – normally thought of as a
function of banks.
As a result of this maturity mismatch, vehicles set up by banks and others are now
finding it extremely difficult to obtain funding through asset-backed commercial paper.
The markets are now withdrawing short-term funding from such vehicles, a process not
unlike a bank run. Many investment vehicles have been forced to shorten the maturity of
their commercial paper, making their borrowing even more short-term and their maturity
mismatch even greater. Other vehicles have been unable to issue at all. For example,
since the beginning of August the value of asset backed commercial paper outstanding in
the US has fallen by almost 20%.
Some investment vehicles will need to be wound up. In many cases, however, the
sponsoring bank will have written a backup line to the vehicle, guaranteeing its funding.
Many of the securitised loans may now be re-priced, restructured or taken back by the
banks. A process is starting that will expand the balance sheet of the banking system.
But how far that process will go is hard to tell.
The vehicles can be taken back onto banks’ balance sheets. Banks as a whole are well
capitalised and should be able to do this. Moreover, the funds that were directed to assetbacked securities and commercial paper will now be available elsewhere. In the end, that funding will come back to the banking system, although between banks the distribution
will differ. So the adjustment period may be awkward and, during it, banks are placing a
premium on holding assets which can quickly be turned into cash.
The increase in demand for liquid assets during the adjustment period is one reason why,
in all the major economies, yields on liquid assets like government securities have fallen.
It also helps to explain why the compensation needed for banks to lend to other banks
over periods longer than overnight has risen and why the volume of inter-bank lending
has been increasingly concentrated at shorter maturities. Since the beginning of August,
the spread between interest rates for 3-month inter-bank lending and central bank interest
rates expected over that period has risen in all the major economies. At present, the
average spread is 110 basis points in sterling and 90 basis points in dollars. This is the
natural economic result of a change in the preferences of banks over the composition of
the assets they wish to hold on their balance sheets.
In addition, banks have raised their demand for reserves at central banks. Banks settle
payments with each other using central bank money and they hold reserves at the Bank of
England to manage their daily payment needs. Conditions in financial markets have
made their payment needs less predictable. As a result, banks have wanted to hold more
reserves. They have tried to fund those reserves by borrowing overnight from other
banks. Over the past month, interest rates on secured overnight borrowing have averaged
5.91% – 16 basis points above Bank Rate. That spread was wider than usual – since the
introduction of the current money market regime, it has averaged 3 basis points.
These changes in the distribution of assets across the financial sector, and banks’
preferences over different assets during the adjustment period, are likely to have
consequences for the wider economy through the interest rates for borrowing and lending
faced by households and companies. It is too soon, however, to quantify the impact on
the economy as a whole.
In the short term, some corporate loan rates will rise in line with inter-bank rates. Banks
that are unable to sell pools of loans that they had securitised, or who need to support offbalance sheet vehicles, may cut back on new lending. But banks whose potential funding
liabilities to vehicles or conduits are small as a proportion of their balance sheet may be
able to exploit profitable lending opportunities, which may not be as open to those banks
which are now hoarding liquidity. So there may be a redirection of borrowing from
within the banking system. This is part of a normal market adjustment.
Funds that had been invested in asset-backed commercial paper issued by vehicles and
conduits will find their way back to the financial system, perhaps directly through bank
deposits or indirectly via the corporate sector by purchases of corporate debt. It is
notable that yields on investment-grade corporate bonds are unchanged since the
beginning of August. And companies, including some financial institutions, have been
able to issue long-term debt.
Nevertheless, there has since mid-July been a widespread reassessment of the
compensation investors seek for bearing risk. Equity prices have fallen in all major
economies. Most of that adjustment took place in July – before the turmoil in credit
markets. The FTSE All-Share today is 6% below its level at the beginning of July. As
this re-pricing of risk passes through to borrowers, the supply of credit faced by
households and companies may tighten somewhat.
In summary, the turmoil in financial markets since the beginning of August stems from a
reluctance by investors to purchase financial instruments backed by loans. Liquidity in
asset-backed markets has dried up and a process of re-intermediation has begun, in which
banks move some way back towards their traditional role taking deposits and lending
them. That process is likely to be temporary but it may not be smooth. During that
process, demand for liquidity by the banking system has increased, leading to a
substantial rise in inter-bank rates.
2. What can and should central banks do to alleviate these problems?
Three distinct policy instruments can be deployed by central banks: interest rates, money
market operations, and other general liquidity support operations.
First, what role should monetary policy play in the present situation? The answer is to
protect the public from the consequences of the recent turmoil by continuing to maintain
economic stability. That is done by setting interest rates in order to meet the 2% target
for inflation. Interest rates are a flexible tool and can be adjusted quickly when
necessary. If, in the wake of a shock to the financial system, the terms on which the
financial system extends credit to the private sector become less favourable, then
borrowing and overall demand would weaken. Other things being equal, that would
lower the inflation outlook. Of course, other things are not equal. When the Monetary
Policy Committee meets each month it reviews all the evidence on the outlook on
inflation before reaching a judgment. The August Inflation Report implied that some
slowdown from recent strong rates of economic growth was needed to meet the inflation
target. The new element introduced by the recent turmoil is that effective borrowing
rates facing households and companies will rise somewhat. So, as we said in the August
Report, the Committee is monitoring credit conditions intensively. It is too soon to tell
how persistent and how large any change in credit conditions for household and corporate
borrowers will prove to be. A new Bank of England Credit Conditions Survey will be
available to the MPC at its next meeting.
Second, the central bank is responsible for the smooth functioning of the payment system
among banks – the short-term money markets and what is known as the high value
payment system. Central banks discharge that responsibility by providing reserves that
enable banks to settle among themselves. In the reform of our money market operations
a year ago, we made very clear, and this is a unique feature of the British system, that the
banking system as a whole will get the reserves that it itself requests. Each month, at the
beginning of what is known as the maintenance period, running from one MPC meeting
to the next, banks set their own reserve targets. They are not imposed. We then supply
the reserves that the banking system as a whole requests. The objective is to allow banks
to deal with their own day-to-day liquidity needs and, by supplying in aggregate the
banks’ demand for reserves, to keep the overnight interest rate close to Bank Rate set by
the Monetary Policy Committee. If any individual bank has misjudged its reserves target
and finds that on any day, due to unusually large payment flows, it needs additional
liquidity, then that is supplied against eligible collateral at a penalty rate. There is
automatic and guaranteed access to the standing facility in return for eligible collateral
and a penalty rate of 1% above Bank Rate. It should be clear that because standing
facilities are available at the borrower’s discretion and against eligible collateral, they are
quite distinct from what is known in other financial centres as “emergency liquidity
assistance”, and under the UK tripartite framework as lender of last resort arrangements,
where the central bank decides that there is a policy objective in lending to one or more
institutions. Reflecting these different aims, the collateral required is different.
The interest rate for secured overnight borrowing was, in August, unusually high relative
to Bank Rate, indicating that banks’ aggregate demand for central bank reserves had risen
since they set their reserves targets. For the current maintenance period, which began on
6 September, the reserves banks raised their target levels of reserves by 6%. That larger
quantity of reserves was supplied by the Bank of England in its open market operation on
6 September.
As expected, some pressure on interest rates for overnight borrowing was relieved. Last
week, we announced that, during the current maintenance period, we will make available
to banks additional reserves, up to 25% of the reserves target, if the secured overnight
rate remains higher than usual relative to Bank Rate. The reason for this is that there are
grounds for suspecting that banks may, at the start of the current maintenance period,
have underestimated their demand for reserves, and the additional reserves will help to
bring the overnight rate into line with Bank Rate. We will announce the terms of this
week’s operation on Thursday. Provision of central bank reserves, in exchange for highquality
collateral, cannot be expected to narrow the spreads between anticipated policy
rates and the rates at which commercial banks can borrow from each other at longer
maturities, and has not done so elsewhere.
So, third, is there a case for the provision of additional central bank liquidity against a
wider range of collateral and over longer periods in order to reduce market interest rates
at longer maturities? This is the most difficult issue facing central banks at present and
requires a balancing act between two different considerations. On the one hand, the
provision of greater short-term liquidity against illiquid collateral might ease the process
of taking the assets of vehicles back onto bank balance sheets and so reduce term market
interest rates. But, on the other hand, the provision of such liquidity support undermines
the efficient pricing of risk by providing ex post insurance for risky behaviour. That
encourages excessive risk-taking, and sows the seeds of a future financial crisis. So
central banks cannot sensibly entertain such operations merely to restore the status quo
ante. Rather, there must be strong grounds for believing that the absence of ex post
insurance would lead to economic costs on a scale sufficient to ignore the moral hazard in
the future. In this event, such operations would seek to ensure that the financial system
continues to function effectively.
As we move along a difficult adjustment path there are three reasons for being careful
about where to tread. First, the hoarding of liquidity is a finite process. When any
transfers of the assets of vehicles back onto banks’ balance sheets are complete, the
demand for additional liquidity, and the associated rise in LIBOR spreads, will fall back.
The fragility of sentiment at present means that the system is vulnerable to further shocks
and it is important to monitor financial conditions extremely closely. But the banking
system as a whole is strong enough to withstand the impact of taking onto the balance
sheet the assets of conduits and other vehicles.
Second, the private sector will gradually re-establish valuations of most asset backed
securities, thus allowing liquidity in those markets to build up. Indeed, there are market
incentives to speed up the process both of taking assets back onto balance sheets and to
re-open markets in securities that have closed. Already there are tentative steps in this
direction which will allow the price discovery process to restart. Strong institutions have
incentives to reveal their positions to obtain better access to funding. Some are tapping
long-term paper. And there are opportunities to make money for those who can assess
and value instruments and eventually repackage and reissue them. Difficult and timeconsuming though that process may be, it will also slowly reduce that part of the rise in
market rates which reflects counterparty risk.
Third, the moral hazard inherent in the provision of ex post insurance to institutions that
have engaged in risky or reckless lending is no abstract concept. The risks of the
potential maturity transformation undertaken by off-balance sheet vehicles were not fully
priced. The increase in maturity transformation implied by a change in the effective
liquidity in the markets for asset-backed securities was identified as a risk by a wide
range of official publications, including the Bank of England’s Financial Stability
Report, over several years. If central banks underwrite any maturity transformation that
threatens to damage the economy as a whole, it encourages the view that as long as a
bank takes the same sort of risks that other banks are taking then it is more likely that
their liquidity problems will be insured ex post by the central bank. The provision of
large liquidity facilities penalises those financial institutions that sat out the dance,
encourages herd behaviour and increases the intensity of future crises.
In addition, central banks, in their traditional lender of last resort (LOLR) role, can lend
“against good collateral at a penalty rate” to an individual bank facing temporary
liquidity problems, but that is otherwise regarded as solvent. The rationale would be that
the failure of such a bank would lead to serious economic damage, including to the
customers of the bank. The moral hazard of an increase in risk-taking resulting from the
provision of LOLR lending is reduced by making liquidity available only at a penalty
rate. Such operations in this country are covered by the tripartite arrangements set out in
the MOU between the Treasury, Financial Services Authority and the Bank of England.
Because they are made to individual institutions, they are flexible with respect to type of
collateral and term of the facility. LOLR operations remain in the armoury of all central
banks.
Conclusions
The path ahead is uncertain. There are strong private incentives to market players to
recognise early and transparently their exposures to off-balance sheet entities and to
accelerate the re-pricing of asset-backed securities. Policy actions must be supportive of
this process. Injections of liquidity in normal money market operations against high
quality collateral are unlikely by themselves to bring down the LIBOR spreads that
reflect a need for banks collectively to finance the expansion of their balance sheets. To
do that, general injections of liquidity against a wider range of collateral would be
necessary. But unless they were made available at an appropriate penalty rate, they
would encourage in future the very risk-taking that has led us to where we are. All
central banks are aware that there are circumstances in which action might be necessary
to prevent a major shock to the system as a whole. Balancing these considerations will
pose considerable challenges, and in present circumstances judging that balance is
something we do almost daily.
The key objectives remain, first, the continuous pursuit of the inflation target to maintain
economic stability and, second, ensuring that the financial system continues to function
effectively, including the proper pricing of risk. If risk continues to be under-priced, the
next period of turmoil will be on an even bigger scale. The current turmoil, which has at
its heart the earlier under-pricing of risk, has disturbed the unusual serenity of recent
years, but, managed properly, it should not threaten our long-run economic stability.
m* strongly disagreed with this view and held out the example of BOE's Mervyn King as a counterweight to the luminaries calling for easing. In typical fashion, King's voice during this period has thus far been conspicuous by it's absence, until today when King broke the silence with his first comments weeks into the current crisis in the money markets and structured debt markets. In a statement prepared for regularly scheduled testimony to the Treasury next week, King sends an eloquent, reasoned message to the markets about the hazards of short term, emotionally driven thinking and the responsibility of a central banker. The short of it is captured by headline-of-the-day award winner and frequent source Macro Man with "No Soup for You!"
TURMOIL IN FINANCIAL MARKETS: WHAT CAN CENTRAL BANKS DO?
Paper submitted to the Treasury Committee
Mervyn King, Governor of the Bank of England
The recent turmoil in financial markets has increased uncertainty in the world economy.
Problems that surfaced first in the US sub-prime mortgage market are now visible more
widely. All those involved, whether banks, other financial institutions, regulators or
central banks, need to analyse carefully the causes of the recent turmoil and think through
the long-term consequences of any actions if they are to respond appropriately.
So in this note I shall try to answer two questions. First, what are the immediate causes
of the recent turmoil and what are its implications? Second, what can and should central
banks do to alleviate the problems? In due course we shall all have time for a more
detailed examination of this episode and the lessons to be learned from it.
1. What are the immediate causes of the recent turmoil and what are its implications?
Since the beginning of August, there have been sharp movements in financial markets:
prices of loans, and assets backed by loans, have fallen; prices of government securities
have risen; and interest rates on inter-bank lending have risen.
Rising default rates on sub-prime mortgages in the United States were the trigger for the
recent financial market turmoil. It is important, though, to put recent events in
perspective. The world economy has been strong for the past five years. Our own
economy has been growing at a steady rate for a considerable period. There are major
problems in the US housing market to which the authorities there are responding with
both macro and micro measures. But the losses from defaults so far remain small relative
to the capital of the banking system.
None of this is meant to say we should be complacent. But the source of the problems
lies not in the state of the world economy, but in a mis-pricing of risk in the financial
system. And it is on that set of issues that we need to focus to determine the remedies,
both short-term to address the current problems and long-term to prevent a recurrence.
Why have developments in one part of the US mortgage market proved so important for a
wide range of financial markets? Sub-prime mortgages are one type of loan that banks
have parcelled together into securities backed by the cash flows from those loans – a
process known as securitisation. Those securities have been sold by banks to investors.
They have also been sold to investment vehicles, many of which have been established
by the banks themselves. Many of these vehicles have financed their purchases by
issuing short-term commercial paper.
Securitisation of loans has separated the information held by loan originators from those
exposed to the risk of default – investors in asset-backed securities or commercial paper.
The unexpected losses sustained on assets backed by US sub-prime mortgages have
highlighted the potential costs to investors of uncertainty about the types of loans
underlying the assets they purchase. So for the time being the markets in these
instruments have either closed or become very illiquid. Vehicles financed by short-term
commercial paper are holding assets which can no longer be traded in liquid markets.
They now find that they have borrowed short to lend long – normally thought of as a
function of banks.
As a result of this maturity mismatch, vehicles set up by banks and others are now
finding it extremely difficult to obtain funding through asset-backed commercial paper.
The markets are now withdrawing short-term funding from such vehicles, a process not
unlike a bank run. Many investment vehicles have been forced to shorten the maturity of
their commercial paper, making their borrowing even more short-term and their maturity
mismatch even greater. Other vehicles have been unable to issue at all. For example,
since the beginning of August the value of asset backed commercial paper outstanding in
the US has fallen by almost 20%.
Some investment vehicles will need to be wound up. In many cases, however, the
sponsoring bank will have written a backup line to the vehicle, guaranteeing its funding.
Many of the securitised loans may now be re-priced, restructured or taken back by the
banks. A process is starting that will expand the balance sheet of the banking system.
But how far that process will go is hard to tell.
The vehicles can be taken back onto banks’ balance sheets. Banks as a whole are well
capitalised and should be able to do this. Moreover, the funds that were directed to assetbacked securities and commercial paper will now be available elsewhere. In the end, that funding will come back to the banking system, although between banks the distribution
will differ. So the adjustment period may be awkward and, during it, banks are placing a
premium on holding assets which can quickly be turned into cash.
The increase in demand for liquid assets during the adjustment period is one reason why,
in all the major economies, yields on liquid assets like government securities have fallen.
It also helps to explain why the compensation needed for banks to lend to other banks
over periods longer than overnight has risen and why the volume of inter-bank lending
has been increasingly concentrated at shorter maturities. Since the beginning of August,
the spread between interest rates for 3-month inter-bank lending and central bank interest
rates expected over that period has risen in all the major economies. At present, the
average spread is 110 basis points in sterling and 90 basis points in dollars. This is the
natural economic result of a change in the preferences of banks over the composition of
the assets they wish to hold on their balance sheets.
In addition, banks have raised their demand for reserves at central banks. Banks settle
payments with each other using central bank money and they hold reserves at the Bank of
England to manage their daily payment needs. Conditions in financial markets have
made their payment needs less predictable. As a result, banks have wanted to hold more
reserves. They have tried to fund those reserves by borrowing overnight from other
banks. Over the past month, interest rates on secured overnight borrowing have averaged
5.91% – 16 basis points above Bank Rate. That spread was wider than usual – since the
introduction of the current money market regime, it has averaged 3 basis points.
These changes in the distribution of assets across the financial sector, and banks’
preferences over different assets during the adjustment period, are likely to have
consequences for the wider economy through the interest rates for borrowing and lending
faced by households and companies. It is too soon, however, to quantify the impact on
the economy as a whole.
In the short term, some corporate loan rates will rise in line with inter-bank rates. Banks
that are unable to sell pools of loans that they had securitised, or who need to support offbalance sheet vehicles, may cut back on new lending. But banks whose potential funding
liabilities to vehicles or conduits are small as a proportion of their balance sheet may be
able to exploit profitable lending opportunities, which may not be as open to those banks
which are now hoarding liquidity. So there may be a redirection of borrowing from
within the banking system. This is part of a normal market adjustment.
Funds that had been invested in asset-backed commercial paper issued by vehicles and
conduits will find their way back to the financial system, perhaps directly through bank
deposits or indirectly via the corporate sector by purchases of corporate debt. It is
notable that yields on investment-grade corporate bonds are unchanged since the
beginning of August. And companies, including some financial institutions, have been
able to issue long-term debt.
Nevertheless, there has since mid-July been a widespread reassessment of the
compensation investors seek for bearing risk. Equity prices have fallen in all major
economies. Most of that adjustment took place in July – before the turmoil in credit
markets. The FTSE All-Share today is 6% below its level at the beginning of July. As
this re-pricing of risk passes through to borrowers, the supply of credit faced by
households and companies may tighten somewhat.
In summary, the turmoil in financial markets since the beginning of August stems from a
reluctance by investors to purchase financial instruments backed by loans. Liquidity in
asset-backed markets has dried up and a process of re-intermediation has begun, in which
banks move some way back towards their traditional role taking deposits and lending
them. That process is likely to be temporary but it may not be smooth. During that
process, demand for liquidity by the banking system has increased, leading to a
substantial rise in inter-bank rates.
2. What can and should central banks do to alleviate these problems?
Three distinct policy instruments can be deployed by central banks: interest rates, money
market operations, and other general liquidity support operations.
First, what role should monetary policy play in the present situation? The answer is to
protect the public from the consequences of the recent turmoil by continuing to maintain
economic stability. That is done by setting interest rates in order to meet the 2% target
for inflation. Interest rates are a flexible tool and can be adjusted quickly when
necessary. If, in the wake of a shock to the financial system, the terms on which the
financial system extends credit to the private sector become less favourable, then
borrowing and overall demand would weaken. Other things being equal, that would
lower the inflation outlook. Of course, other things are not equal. When the Monetary
Policy Committee meets each month it reviews all the evidence on the outlook on
inflation before reaching a judgment. The August Inflation Report implied that some
slowdown from recent strong rates of economic growth was needed to meet the inflation
target. The new element introduced by the recent turmoil is that effective borrowing
rates facing households and companies will rise somewhat. So, as we said in the August
Report, the Committee is monitoring credit conditions intensively. It is too soon to tell
how persistent and how large any change in credit conditions for household and corporate
borrowers will prove to be. A new Bank of England Credit Conditions Survey will be
available to the MPC at its next meeting.
Second, the central bank is responsible for the smooth functioning of the payment system
among banks – the short-term money markets and what is known as the high value
payment system. Central banks discharge that responsibility by providing reserves that
enable banks to settle among themselves. In the reform of our money market operations
a year ago, we made very clear, and this is a unique feature of the British system, that the
banking system as a whole will get the reserves that it itself requests. Each month, at the
beginning of what is known as the maintenance period, running from one MPC meeting
to the next, banks set their own reserve targets. They are not imposed. We then supply
the reserves that the banking system as a whole requests. The objective is to allow banks
to deal with their own day-to-day liquidity needs and, by supplying in aggregate the
banks’ demand for reserves, to keep the overnight interest rate close to Bank Rate set by
the Monetary Policy Committee. If any individual bank has misjudged its reserves target
and finds that on any day, due to unusually large payment flows, it needs additional
liquidity, then that is supplied against eligible collateral at a penalty rate. There is
automatic and guaranteed access to the standing facility in return for eligible collateral
and a penalty rate of 1% above Bank Rate. It should be clear that because standing
facilities are available at the borrower’s discretion and against eligible collateral, they are
quite distinct from what is known in other financial centres as “emergency liquidity
assistance”, and under the UK tripartite framework as lender of last resort arrangements,
where the central bank decides that there is a policy objective in lending to one or more
institutions. Reflecting these different aims, the collateral required is different.
The interest rate for secured overnight borrowing was, in August, unusually high relative
to Bank Rate, indicating that banks’ aggregate demand for central bank reserves had risen
since they set their reserves targets. For the current maintenance period, which began on
6 September, the reserves banks raised their target levels of reserves by 6%. That larger
quantity of reserves was supplied by the Bank of England in its open market operation on
6 September.
As expected, some pressure on interest rates for overnight borrowing was relieved. Last
week, we announced that, during the current maintenance period, we will make available
to banks additional reserves, up to 25% of the reserves target, if the secured overnight
rate remains higher than usual relative to Bank Rate. The reason for this is that there are
grounds for suspecting that banks may, at the start of the current maintenance period,
have underestimated their demand for reserves, and the additional reserves will help to
bring the overnight rate into line with Bank Rate. We will announce the terms of this
week’s operation on Thursday. Provision of central bank reserves, in exchange for highquality
collateral, cannot be expected to narrow the spreads between anticipated policy
rates and the rates at which commercial banks can borrow from each other at longer
maturities, and has not done so elsewhere.
So, third, is there a case for the provision of additional central bank liquidity against a
wider range of collateral and over longer periods in order to reduce market interest rates
at longer maturities? This is the most difficult issue facing central banks at present and
requires a balancing act between two different considerations. On the one hand, the
provision of greater short-term liquidity against illiquid collateral might ease the process
of taking the assets of vehicles back onto bank balance sheets and so reduce term market
interest rates. But, on the other hand, the provision of such liquidity support undermines
the efficient pricing of risk by providing ex post insurance for risky behaviour. That
encourages excessive risk-taking, and sows the seeds of a future financial crisis. So
central banks cannot sensibly entertain such operations merely to restore the status quo
ante. Rather, there must be strong grounds for believing that the absence of ex post
insurance would lead to economic costs on a scale sufficient to ignore the moral hazard in
the future. In this event, such operations would seek to ensure that the financial system
continues to function effectively.
As we move along a difficult adjustment path there are three reasons for being careful
about where to tread. First, the hoarding of liquidity is a finite process. When any
transfers of the assets of vehicles back onto banks’ balance sheets are complete, the
demand for additional liquidity, and the associated rise in LIBOR spreads, will fall back.
The fragility of sentiment at present means that the system is vulnerable to further shocks
and it is important to monitor financial conditions extremely closely. But the banking
system as a whole is strong enough to withstand the impact of taking onto the balance
sheet the assets of conduits and other vehicles.
Second, the private sector will gradually re-establish valuations of most asset backed
securities, thus allowing liquidity in those markets to build up. Indeed, there are market
incentives to speed up the process both of taking assets back onto balance sheets and to
re-open markets in securities that have closed. Already there are tentative steps in this
direction which will allow the price discovery process to restart. Strong institutions have
incentives to reveal their positions to obtain better access to funding. Some are tapping
long-term paper. And there are opportunities to make money for those who can assess
and value instruments and eventually repackage and reissue them. Difficult and timeconsuming though that process may be, it will also slowly reduce that part of the rise in
market rates which reflects counterparty risk.
Third, the moral hazard inherent in the provision of ex post insurance to institutions that
have engaged in risky or reckless lending is no abstract concept. The risks of the
potential maturity transformation undertaken by off-balance sheet vehicles were not fully
priced. The increase in maturity transformation implied by a change in the effective
liquidity in the markets for asset-backed securities was identified as a risk by a wide
range of official publications, including the Bank of England’s Financial Stability
Report, over several years. If central banks underwrite any maturity transformation that
threatens to damage the economy as a whole, it encourages the view that as long as a
bank takes the same sort of risks that other banks are taking then it is more likely that
their liquidity problems will be insured ex post by the central bank. The provision of
large liquidity facilities penalises those financial institutions that sat out the dance,
encourages herd behaviour and increases the intensity of future crises.
In addition, central banks, in their traditional lender of last resort (LOLR) role, can lend
“against good collateral at a penalty rate” to an individual bank facing temporary
liquidity problems, but that is otherwise regarded as solvent. The rationale would be that
the failure of such a bank would lead to serious economic damage, including to the
customers of the bank. The moral hazard of an increase in risk-taking resulting from the
provision of LOLR lending is reduced by making liquidity available only at a penalty
rate. Such operations in this country are covered by the tripartite arrangements set out in
the MOU between the Treasury, Financial Services Authority and the Bank of England.
Because they are made to individual institutions, they are flexible with respect to type of
collateral and term of the facility. LOLR operations remain in the armoury of all central
banks.
Conclusions
The path ahead is uncertain. There are strong private incentives to market players to
recognise early and transparently their exposures to off-balance sheet entities and to
accelerate the re-pricing of asset-backed securities. Policy actions must be supportive of
this process. Injections of liquidity in normal money market operations against high
quality collateral are unlikely by themselves to bring down the LIBOR spreads that
reflect a need for banks collectively to finance the expansion of their balance sheets. To
do that, general injections of liquidity against a wider range of collateral would be
necessary. But unless they were made available at an appropriate penalty rate, they
would encourage in future the very risk-taking that has led us to where we are. All
central banks are aware that there are circumstances in which action might be necessary
to prevent a major shock to the system as a whole. Balancing these considerations will
pose considerable challenges, and in present circumstances judging that balance is
something we do almost daily.
The key objectives remain, first, the continuous pursuit of the inflation target to maintain
economic stability and, second, ensuring that the financial system continues to function
effectively, including the proper pricing of risk. If risk continues to be under-priced, the
next period of turmoil will be on an even bigger scale. The current turmoil, which has at
its heart the earlier under-pricing of risk, has disturbed the unusual serenity of recent
years, but, managed properly, it should not threaten our long-run economic stability.
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