My Travels to Jerusalem

Palestine: The Oslo Accords before and after, My travels to Jerusalem By Warren L Coats (2021) Kindle and paperback versions available at: Oslo Accords: Before and After

An intimate account of the establishment of the Palestine Monetary Authority and related adventures by one of the International Monetary Fund’s post-conflict, transition economy monetary experts. From being stranded in the desert without a cell phone, to hearing the sound at breakfast of a suicide bomber, to meeting with Yasser Arafat, and Stanley Fischer of the Bank of Israel, the author shares his adventures in the land of Canaan over a sixteen year period.

The establishment of the State of Israel in 1948 in Israel’s ancestral homeland required dealing with Palestine’s existing residents. In the Six-Day War in 1967, Israel’s occupation of the territories given to the Palestinians when the United Nations first recognized the State of Israel (the West Bank and Gaza Strip) increased pressure to resolve that issue. The Oslo Accords offered a path to its resolution, based on an agreement between Yasser Arafat, representing the Palestinian people, and the government of Israel, to swap land for peace (the return of Palestinian lands in exchange for Palestinian recognition of the State of Israel and its right to exist in peace).

One of the elements of the Oslo Accords was the establishment of a central bank in the Occupied Territories. Between 1995 and 2011 Warren Coats lead or participated in the missions of the International Monetary Fund to assist the Palestinian Authority in establishing and developing the capacities of the Palestine Monetary Authority. This book recounts the highlights of his visits, which included meetings with Arafat, as well as Bank of Israel officials.

Previous Books

One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina by Warren Coats (2007)   Hard cover: One Currency for Bosnia

FSU: Building Market Economy Monetary Systems–My Travels in the Former Soviet Union By Warren L Coats (2020)  Kindle and paperback versions available at: FSU-Building-Economy-Monetary-Systems

Afghanistan: Rebuilding the Central Bank after 9/11 — My Travels to Kabul By Warren Coats (2020)  Kindle and paperback versions available at:  “Afghanistan-Rebuilding the Central Bank after 9/11”

Iraq: An American Tragedy, My Travels to Baghdad By Warren Coats (2020) Kindle and paperback versions available at: Iraq-American-Tragedy-My-Travels-Baghdad

Zimbabwe: Challenges and Policy Options after Hyperinflation by Warren L. Coats (Author), Geneviève Verdier (Author)  Format: Kindle Edition Zimbabwe-Challenges and Policy Options after Hyperinflation-ebook

Money and Monetary Policy in Less Developed Countries: A Survey of Issues and Evidence by Warren L. Coats (Author, Editor), Deena R. Khatkhate (Author, Editor)  Format: Kindle Edition Money and Monetary Policy in LDCs-ebook

Central Banking award

The Central Banking Journal annually awards central bankers (best governor, best central bank, and providers of services to central banks) for their performance.  This year’s ceremony was held in London on March 13 and I was awarded Outstanding Contribution for Capacity Building. Here is a video of my acceptance speech.


A proposal for the Fed’s balance sheet

By Warren Coats[1]

To save financial institutions from the collapse that threatened them after the bankruptcy of Lehman Brothers in September 2008, the Federal Reserve purchased government securities and Mortgage Backed Securities (MBS) sufficient to increase the size of its asset holdings from $0.9 trillion to $4.5 trillion by the end of 2014.  These large open market purchases were not meant to increase the money supply, the traditional purpose of such operations, which after a sharp drop followed by a sharp increase in the growth rate of broad money (M2) has grown at its historical average rate of around 6% per year. Rather they were to support the market prices of government debt and hard to price MBS in the face of market panic (at least initially).

The Fed accomplished this trick (large increase in the Fed’s asset holding with only modest increases in the money supply) by paying banks to keep the proceeds of their sales of securities to the Fed in deposits with the Fed, so called “reserves,” in excess of what is required, so called “excess reserves.”  Beginning in October 2008, the Fed began to pay interest on bank required and excess reserves deposited with Federal Reserve banks.  This kept broad money from growing in response to the huge increases in base money (the counterpart of the securities purchased by the Fed) and became the primary tool of monetary policy.

The Fed is now pondering what to do about its abnormally large balance sheet.  A year ago it announced its intention to gradually reduce the size of its asset portfolio in order to return to its traditional policy tools—regulating the growth in bank money and credit by targeting the overnight interbank lending rate (the Fed funds rate) via open market operations.  After having suspended the open market purchases that had inflated its balance sheet in recent years (QEs 1, 2, and 3), in October 2017 the Fed stopped replacing the maturing securities it held to the extend of about $20 billion per month.  As a result its asset holdings dropped about $150 billion in the nine months since then and by the end of June 2018 stood at $4,315 billion.  Its current intention is to reduce its asset holdings to $3 trillion by the end of 2022.

The reduction in the Fed’s holdings of these securities (Treasuries and MBSs) is an increase in the market’s holdings of them, other things equal.  But other things are not expected to be equal.  Our profligate government is expected to run a one trillion dollar deficit in 2019, adding that amount of government debt to the market on top of the Fed’s additions.  The Congressional Budget Office projects a worsening federal deficit every year over the next ten of its official forecast, worsening even as a percent of GDP. This will put pressure on the Fed to rain in or suspend its program to return its asset holdings to more traditional levels.

There is a better way to handle this difficult situation.  Bank reserves with the Fed are currently about $2 trillion (the rest of the Fed’s monetary liabilities is Currency in Circulation of $1.7 trillion) and banks’ checkable deposits are about the same amount (of which demand deposits are $1.5 trillion).  Requiring 100% reserve backing of checkable deposits was recommended in the 1930s by a group of University of Chicago economists as a way to protect our payment system from the loan default problems being experienced by many banks at the time.  This so called Chicago Plan would remove any risks to checkable deposits, a key part of our payment system, and thus eliminate the need for deposit insurance for such deposits.  Required reserves would continue to earn interest as they do now, but excess reserves would not.  But in addition to strengthening our payment system, adopting the Chicago Plan today would convert existing excess reserves into required reserves and end the debate over whether to further shrink the Fed’s balance sheet.

Adopting the Chicago Plan would prevent banks from on lending our checkable deposits.  At the moment they are not doing that anyway. This raises the question of where banks would get the funds (our savings) to on lend in their financial intermediary role?  In an extreme version of the Chicago Plan (100% required reserves against all deposits and deposit like bank liabilities) all bank lending would be finance by equity rather than debt.  Savers would hold claims on the value of a portfolio of loans as they now do with mutual fund investments and as in some Islamic banking instruments.  Equity rather than debt financed bank intermediation is a more stable structure as a result of shifting the risk of loses (loan defaults) from banks to the ultimate public investors.  The Federal Deposit Insurance Company would stop insuring 100% reserved deposits and its bank resolution functions would be moved to the Office of the Comptroller of the Currency (OCC) in the U.S. Department of the Treasury.

For purposes of requiring a 100% reserve and dropping deposit insurance, a more pragmatic boundary between all deposit liabilities and checkable deposits might include savings deposits (which can generally be shifted into checkable deposits almost automatically) and time deposits with a maturity of less than six months (or maybe three months).  This would add almost $10 trillion dollars to required reserves and would need to be phased in gradually.  The Fed would need to buy an equivalent amount of government securities in order to finance the increase in required reserves without contracting the money supply or bank credit.

It is very desirable to separate our payment system (checkable deposits of one definition or another) from the necessarily risky lending by banks and other financial institutions and make our money (currency and deposits) risk free.  Doing so would allow banks to take whatever risks with investor funds those investors are willing to finance.  This would enable a significant reduction in the government’s regulations of these activities.  “Changing Direction on Bank Regulation” Cayman Financial Review April 2015

[1]Dr. Coats retired from the International Monetary Fund in 2003 and is a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.

Looking Back on Occupy Wall Street

The evening of September 16, 2008, I met Randy Kroszner for dinner at Et Voila in the Palisades just outside of Georgetown. He arrived late explaining that the Fed’s monthly monetary policy meeting had lasted longer than expected. Randy is a Governor on the Board of Governors of the Federal Reserve. The attempt to rescue Lehman Brothers over the weekend had failed and it had declared bankruptcy the day before, so we had a lot of interesting things to talk about. Randy didn’t mention that the Fed had just agreed to lend up to $85 billion to AIG to cover its expected loses on its mortgage related Credit Default Swaps, thus giving the U.S. government a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. When news of the AIG bailout was posted on my phone around 9:00pm during our meal, I asked Randy what in the world was going on. He was reluctant to discuss the topic uncertain whether the source of my news was a leak or an official Fed press release.

The housing bubble had started to deflate in 2007 and homeowners and their mortgage financiers were coming to grips with the reality of significant financial losses. “The DEFs of the Financial Markets Crisis” and “The Big Bailout–What Next?” While the Federal Reserve quickly reacted to inject liquidity into the banking system to compensate for the freezing up of the interbank credit market that followed the Lehman Brothers-AIG shockwaves, the key questions were who would bear these losses and how should they be contained to avoid spilling over to the financial system more broadly.

The Fed, with the help of $700 billion authorized by Congress in the Troubled Asset Relieve Program (TARP), bailed out Wall Street and contained the spread of potential bank failures. It was a scary time for all involved. Looking back from the relative calm of today with criticism of policy actions taken then is a bit unfair but how else are we to learn from experience?

The government actions in 2008 can be broadly stated as: a) providing all of the liquidity the financial sector needed following the Lehman Brothers collapse and financial panic; b) bailing out large banks and other financial institutions that might have been insolvent whether they were or not; and c) leaving underwater homeowners to drown. The first of these—providing liquidity—is universally accepted as a proper function of a central bank and one that the Fed executed well. The other two—bailing out banks but not homeowners—are the subjects of this note. I will review them from both an economic and a political perspective.

The economic rational for bailing out Wall Street was that there was a risk, with very uncertain probability, of the failure of large Wall Street institutions spilling over to and bankrupting other financial institutions holding assets in the failed Wall Street firms. Many of them were foreign (especially German Landesbanks) and no one knew for sure where the contagion might end. By saving Wall Street, the argument went, the government was saving Main Street as well (trickle down). Sheila Bair, then the Chairman of the Federal Deposit Insurance Corporation, among others urged the government to bail out homeowners who were defaulting on their mortgages as well. While different policies of homeowner relief were considered the one finally adopted, Home Affordable Refinance Program—HARP, was modest and left Ms. Bair quite unhappy: “Shortly after Fannie Mae and Freddie Mac announced their new plan, Ms. Bair declared that it was inadequate and pointedly said that the government had spent hundreds of billions of dollars to bail out financial institutions like American International Group, the giant insurer.” “White House scales back a Mortgage relief plan”

From economists’ perspective, bailing out anyone creates a moral hazard. If market players profit from risky bets when successful but expect that the government will pick up the tab when they are unsuccessful, they will take greater (excessive) risks. No one was eager to bail out property flippers (those who bought property with the intention of reselling it at a higher price rather than move in) from their failed gamble. But the same logic applies to those financial firms that lent the mortgage money in the first place or that kept the financing cheap by providing it from the derivatives market of Mortgage Backed Securities, etc. Government policy makers attempted to design their bailouts to minimize the moral hazard they were creating, especially after the foolish and panic driven bailout of Bear Stearns in March 2008. But policy was driven by government’s fear of financial contagion.

The political optics of bailing out mortgage lenders but not homeowners is not good. Why did politicians choose to support one but not the other? Moral hazard is a problem with both. The reality is that Washington politicians were (are) much closer to Wall Street than to Main Street and are thus more sensitive to Wall Street’s concerns. Growing recognition of this fact adds some understanding to the hostile attitudes toward Washington expressed by Trump supporters.

By far the better policy would have been, and in the future is, to stick by the existing rules for bearing losses (our bankruptcy and default laws), i.e. no government bailouts. Our bankruptcy laws and procedures are actually quite good. “Resolving Failed Banks” For starters Bear Stearns shareholders should have lost everything. On the underwater homeowner side, mortgage lenders have always sought to minimize their losses when borrowers are unable to repay according to the original terms of a loan. Often the least cost resolution is for the lender to agree to easier terms and to restructure the loan. Evicting the “owner” and selling the property, especially when it is under water (i.e. valued at less than the mortgage amount), is a costly undertaking and writing down and restructuring the loan is often the least cost approach. However, government driven programs can rarely match the lenders’ ability to restructure loans one by one that can be honored by the homeowner while minimizing the loss to the lender. “Changing direction on bank regulation”

Our government has increasingly attempted to micromanage the private sector, especially the financial sector. This is a mistake. It should establish clear and pragmatic rules for conducting business and for resolving failures (workable bankruptcy laws). “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution and Ways to Overcome Them” Within this broad legal framework, which to a large extent already exists, individual firms would be held accountable for the conduct of their business by their customers and their owners. If they fail, the first losses must fall on the owners (shareholders), who have a greater incentive to do well and have better market information on which to act than do government regulators. This requires a change in attitude and direction of government’s role in our lives.

My Political Platform for the Nation – 2017

For me, the ideal American government would deliver its important but limited functions efficiently and effectively and would raise the money to pay for these activities with efficient, minimally distorting (neutral), and fair taxes following a principle of maximum subsidiarity (decisions made and services performed at the most local levels possible). The government should do fewer things than it does now but should do them better and should fully pay for them with taxes and fees (cyclically balanced budgets).

My unrestrained, radical platform will be presented here at a high level of general principles. Details need to be refined by a political process involving public discussion and are likely to evolve somewhat over time. Links to earlier articles provide additional details. In the very broadest terms Americans should be self reliant and free to work and play as hard as they choose with the government supporting their choices by providing security, the legal foundation and framework of private property and contracts, and an efficient safety net when individual undertakings are not feasible or fail.

The limited functions of the Federal government are enumerated in Article 1 section 8 of the U.S. Constitution. Broadly these are to:

  1. Develop and maintain our relations with other countries and international bodies and to maintain an Army, Navy and Air Force for the purposes of defending and promoting the security of the United States;
  2. Establish and enforce the rights to property and contracts and to adjudicate related disputes;
  3. Provide for public safety;
  4. Provide an efficient and effective social safety net (welfare);
  5. “Regulate commerce with foreign Nations, and among the several States;”
  6. “Coin money, regulate the value thereof, and of foreign coin, and fix the Standard of Weights and Measures;”
  7. Arrange for the provision of roads and essential infrastructure; and
  8. Tax, borrow, and levy fees and tariffs to pay for these activities.

Our Social Contract

Sovereignty resides with each individual, who have collectively ceded limited powers to government for the general welfare. Each of us is free, within legal limits on doing harm to others, to lead our own lives and build or work at whatever we choose. Thus the government’s laws apply equally to each of us without regard to our race, religion, sex, or sexual orientation. From this environment of freedom and innovation, America has built the most successful economy in the world.

When building companies or developing products, many will fail and try again. The government provides the legal framework (bankruptcy) for resolving such failures. The implicit agreement between citizens and their government is that government will provide a floor—a safety net—whenever a person’s efforts fail or when, e.g., for health reasons, a person is unable to provide for him or herself. The level of the safety net should reflect the level of the country’s income and social consensus and should be designed to achieve its objective as efficiently as possible with careful consideration of the incentives it creates.

Income redistribution: taxation and a guaranteed minimum income

All income (personal and corporate) taxes should be replaced with a comprehensive, flat, consumption tax (Value Added Tax—VAT) and limited progressivity introduced by paying every legal man, woman and child resident a guaranteed minimum income. US federal tax policy, Cayman Financial Review July 2009 Each recipient of these monthly guaranteed income payments would be required to set aside a minimum amount for health insurance (chosen by each person or family in the competitive market place) and a minimum amount for retirement (invested in qualifying retirement funds in the competitive market place). Saving social security

As the guaranteed minimum income should be at a level sufficient to minimally support life’s basic needs, supplements such as unemployment or disability insurance would not be needed or provided. However, disabilities acquired from military or public safety service should receive additional income support.

Health care

Each person will be responsible for paying for at least part of routine medical care (the copay required by the insurance they have chosen) and will thus care about its cost. The cheapest insurance policies will be limited to major medical expenses (catastrophic health insurance). As everyone will be required to contribute monthly to a health savings account from their guaranteed minimum income, most people will chose to use such funds to buy health insurance, which would not be tied to employment or an employer.

Doctors and hospitals will be required to make medical service costs transparent. On that basis, patients, in consultation with their doctors, will decide the level of care and treatments to receive. These measures will introduce normal market competition into the provision of medical care that is currently absent, which will improve its quality and lower its cost.


Equal access to quality education is a critical element in maximizing opportunity for all and the wealth of our society and each person in it. The public school system has often failed in this objective. While the wealthy can afford to put their children in private schools when the neighborhood school is of poor quality, lower income families generally cannot. Every K-12 aged child will receive a tuition voucher that covers the cost of state provided education. The amount will generally vary from state to state (or school district to school district). The voucher can be used to attend the local neighborhood public school with no additional cost, or any private school the family chooses, which might incur additional costs. Schools eligible to receive such vouchers must meet minimum education standards set by the state and must disclose the performance of their students on state administered achievement tests. This information must be available to the public. The learning progress of each child is more important than the average level of achievement of each school’s students as some schools might well specialize in slow or problem learners and performance data should reflect this distinction. The neighborhood school has the advantage of being easier to get to every day and will normally be chosen by families if it provides a good education. The argument for universal tuition vouchers goes beyond providing a level playing field to all. It also introduces the competition for students that is the basis for good quality, low cost goods and services in every other area of our economy.

Access to higher education raises different issues. Those with the aptitude and desire for a college or postgraduate degree can significantly increase their lifetime incomes as a result. It would hardly be fair to tax the general public to subsidize the higher education of those who will become wealthier as a result. However, the tuition loans that may be needed by those from lower income families to make this investment would be hard to get without insurance against default. Many states also provide community (or Jr.) colleges at public expense that provide training in various trade skills as well as four year college preparatory courses. These seem to have often been successful in leveling the playing field. The optimal structuring of higher education subsidies (e.g. between insurance guarantees and tuition subsidies) needs further examination.

Monetary and Financial Policies

Government policies that affect business should be as rule based and transparent as possible. Monetary policy stands out as a particularly important area in which clearer rules are needed. A currency with stable real value (purchasing power) is an important part of the foundation of efficient free markets. At the very minimum the Federal Reserve’s mandate should be tightened as provided in the very pragmatic Federal Reserve Accountability and Transparency Act of 2014. This act would require the Fed to chose an operational rule, from which it could depart only with an explanation to Congress of its reasons. A deeper review of options is proposed by the Centennial Monetary Commission Act of 2015. I have proposed a more radical reform in the spirit of the gold standard but with tighter rules and an anchor of a large number of goods rather than just gold. The supply of this currency, which ideally would become the global currency, would be regulated by the market using currency board rules and “indirect redeemability.” A hard anchor for the dollar.

The banking and financial sector are currently smothered with detailed regulations the compliance cost of which are driving smaller banks out of business. Under the Dodd Frank law adopted after the financial crisis of 2008, the largest five American banks have grown even larger (in absolute terms and as a share of the banking sector) than they were in 2008. Regulators, despite (or because of) their detailed banking regulations have failed to make banks safer and have slowed the competitive process of producing better and cheaper services. Bank owners and market preferences should regulate risk taking by banks.

Bank regulation by the government should focus on broad principles with strong owner accountability. Bank capital requirements should be raised and the no bail out rules strengthened. Bank owners and investors should absorb any bank losses. The payment services of banks should be isolated from the rest of its lending and investing business by adopting the Chicago Plan of one hundred percent reserve requirements against current account deposits, and virtually all other regulations (other than accounting and reporting standards) should be dropped. Larger banks will develop their own risk weighted capital requirements for their internal use, but the government’s capital requirements should state the minimum required leverage ratio (ratio of core capital to total assets) and set it at a high level. Changing direction on bank regulation, Cayman Financial Review April 2015. A bill now in congress moves in this direction: The Financial Choice Act

Business activities and regulation

The government should only provide services that that private sector can’t. It should provide the legal and regulatory framework for the private economy rather than compete with it. Though the approaches to providing “public goods” such as police, courts, prisons, firemen, parks, highways, airports, etc. have varied over time, they are almost always paid for by the government (i.e. collectively by tax payers) and should be provided efficiently at the level expected by the public. Publicly funded and privately produced goods and services are often sources of hard or soft corruption. Rather than over charging for services or paying bribes to win contracts (hard corruption), soft corruption exploits influence on government to obtain contract terms or regulations favorable to particular firms (“rent seeking”). The government’s purchases of goods and services from the private sector should be governed by transparent rules that promote competition among suppliers. This is easier said than done. Open the Books

While the government is involved in and trying to do far too many things, it doesn’t do many of them very well. Of those services the government needs to provide, states generally perform better than the federal government though performance varies across states. In Maryland, where I live, I was able to register my Limited Liability Company on line in about 30 minutes start to finish. Registering my car and updating my driver’s license is quick and easy. However, it took me months to obtain a statement of my residency from the U.S. Treasury and a personal trip to the State Department to have it certified to provide to the National Bank of Kazakhstan before they could pay me for my services. Getting a passport or green card is more complicated and takes longer than they should. The government should do much less and do it much better.

Those in the government who believe they can judge better than competitive private markets how best to allocate resources (what to invest in and produce) are generally wrong. Moreover, they establish an opportunity and thus incentive for corruption.

The government’s regulation of private businesses in the interest of public safety, environmental protection, and market competition should be limited and subject to very serious cost/benefit tests. Cost/benefit analysis unavoidably reflects subjective judgments but their role should be limited to the extent possible by full transparency of the basis of any assessment. Competitive capitalism vs. the other kinds.

Foreign policy and national security

The purpose of our foreign policy is to serve American security interests and the international rule of law under which American’s can explore the world and American businesses can compete globally on a level playing field. Our security requires a strong military, but it also requires the skillful use of diplomacy. Our military must be structured for defense, not offensive wars of our choosing. Our 2003 war in Iraq and subsequent developments in the Middle East have cost many lives (some American) and treasure, undermined our moral authority, and seriously damaged our security. Our foreign policy should be one of “restraint.”

Our relations with other countries should be based on shared interests consistent with our respect for individual dignity and the rule of law. We should support and, where appropriate, lead international bodies dedicated to developing, promoting, and overseeing compliance with the rule of law internationally. Our international leadership should rest, in addition to our economic and military strength, on our commitment to broadly shared values and standards of behavior. Just as we give up limited amounts of our individual sovereignty to our own government when it serves our individual and collective interests, so should we give up limited amounts of our national sovereignty to international bodies when it serves our national and international interests.

Our economic strength depends in part on providing for a sufficiently strong military in the most economical way possible. Money spent on tanks can be spent on building other businesses and producing goods that we enjoy. The very nature of the relationship between our military and the industries that supply it, what President Eisenhower called “the military industrial complex,” makes achieving this objective very difficult. As argued above, clear rules and transparency are important tools. Our unsupportable empire


Next to the right to personal property, nothing is as central to our liberty and well being as the right to trade. It is the basis of virtually all of our enormous increase in productivity and thus our standard of living. The government impedes our right to trade with a wide range of often unnecessary or excessive regulations. Restricting our freedom to trade across national borders is also a mistake that reduces our standard of living from its potential.

Trade has destroyed some jobs while creating others. “Since 1900, the portion of the U.S. workforce in agriculture has declined from 41 percent to less than 2 percent. Output per remaining farmer and per acre has soared since millions of agricultural workers made the modernization trek from farms to more productive employment in city factories…. Manufacturing’s postwar share of the labor force peaked at about 30 percent” in 1953 and has since declined to less than 9 percent while manufacturing output continued to climb. “Of the 5.6 million manufacturing jobs lost between 2000 and 2010, trade accounted for 13 percent of job losses and productivity improvements accounted for more than 85 percent.” George Will, Washington Post.

As with domestic, competitive trade, those out-performed in competitive markets suffer, at least temporarily. The safety net for “losers” in the competitive process discussed above is an important feature in our willingness to unleash the benefits of free trade. We must insure that they are adequate. We should support the World Trade Organization (WTO) as well as regional and bilateral agreements that reduce the barriers to trade and promote freer trade. Save trade. Globalization and nationalism-good and/or bad?. Trade and globalization


Our government should assume that each of us is capable of and has the right to make our own decisions and lead our own lives as we see fit. Its role is to protect those rights, in part by protecting us from others, foreign and domestic, who would violate them. We are, however, part of and best flourish within broader communities. Our government should develop legal frameworks to facilitate our interactions and relationships within and across societies both business and personal. Our successful flourishing will also depend greatly on a shared culture of mutual respect and comity.

Cayman Financial Review, Q3 2015

Dear Friends,

The Third Quarter issue of the Cayman Financial Review is now available on the web: I am on the Editorial Board and have two articles in this issue that might interest you. The first discusses the continued decline of U.S. world leadership exemplified in the case of the new Asian Infrastructure Investment Bank located in China:

The second is the final installment of my series on the Kabul Bank scandal. The failure of Kabul Bank in Afghanistan was probably the biggest bank failure and fraud in history on a per capital basis.  As this final article looks at some of the legal issues and developments in recovering stolen assets held abroad and Afghanistan’s uneven struggle to strengthen its criminal justice system, Gary Gegenheimer, a lawyer who also worked in Afghanistan, joined me to write this third installment:–Part-III/

I hope that you enjoy them.

Best wishes,


Greece: What should its creditors do now?

Following Sunday’s NO vote in Greece, what ever that might have meant, it is tempting to tell Greece to get lost and be done with them. Aside from the unseemly lack of compassion for our suffering fellow man, the further collapse of the Greek economy and society that would likely follow Grexit (the Greek exit from the Euro and introduction of its own currency) would open unknown and potentially very dangerous risks to the rest of Europe from its southern periphery. However, any new deal between Greece and its creditors should be mutually beneficial for Greece and the EU in the long run and achievable and practical in the short run. What are the key elements needed for such an agreement?

Greece’s second bailout program with its creditors (the EU, ECB, and IMF) expired June 30 after a four-month extension without disbursing the final installment of around $8 billion dollars. It cannot be resurrected. Thus any further discussions between Greece and its creditors will concern a third bailout program.

Greece’s recently replaced and unmissed Finance Minister, Yanis Varoufakis’, stock speech said basically that Greece does not need or want more loans because it is bankrupt rather than illiquid. In short, it wants debt forgiveness. In fact, many European officials have acknowledged the possible need to write off (reduce the present value one way or another of) existing Greek debt but insisted that any such consideration be put off for a new program. Discussion of a new program has now arrived.

The foundation of any financial assistance program with the IMF is its assessment that the borrowing country can repay the loan. This assessment is contained in the IMF’s “Debt Sustainability Analysis.” This analysis imbeds the agreed (or assumed) level of government spending and estimated tax and other government revenue and of the level of economic activity (GDP growth) upon which it depends in a forecasting model of the deficit and debt/GDP ratios expected from implementation of the agreed policies. The IMF was badly embarrassed by its acceptance of overly optimistic assumptions about income growth government revenue in its first bailout program in 2010 with the EU and ECB. Under political pressure from the EU and ECB, these assumptions allowed the IMF to conclude that Greece’s debt would be sustainable thus avoiding the need for some debt write off favored by the IMF but opposed by Germany and France, whose banks held large amounts of that debt. The second bailout program included a write off of about 70% of the privately held Greek debt. However, this came too late and the adjustment in the Greek government’s annual deficits required by the first program proved too severe causing a much larger and longer lasting contraction in the Greek economy than expected and assumed in the IMF Debt Sustainability Analysis at that time.

On June 26, 2015 (i.e. prior to Greece’s default on its $1.7 billion payment to the IMF and to the July 5 referendum) the IMF released a draft Debt Sustainability Analysis based on the information available at that time. It concluded that “If the program had been implemented as assumed, no further debt relief would have been needed under the agreed November 2012 framework…. At the last review in May 2014, Greece’s public debt was assessed to be getting back on a path toward sustainability, though it remained highly vulnerable to shocks. By late summer 2014, with interest rates having declined further, it appeared that no further debt relief would have been needed under the November 2012 framework, if the program were to have been implemented as agreed. But significant changes in policies since then—not least, lower primary surpluses and a weak reform effort that will weigh on growth and privatization—are leading to substantial new financing needs. Coming on top of the very high existing debt, these new financing needs render the debt dynamics unsustainable…. But if the package of reforms under consideration is weakened further—in particular, through a further lowering of primary surplus targets and even weaker structural reforms—haircuts on debt will become necessary.”

In short, the Greek economy was finally beginning to recover by the end of 2014 but the reversals by the new Syriza government of some of the policies contributing to that gain and the loss of market confidence in the muddled and amateurish behavior of the new government reversed the recovery and further increased Greek deficits. In addition, increasing capital flight has been financed by short-term emergency liquidity loans from the ECB, thus adding to Greece’s over all indebtedness. Capital flight per se should not reduce banks’ capital, as they lose the same amount of assets and liabilities, as long as they are able to liquidate sufficient assets by selling them or by using them as collateral for loans from the ECB or other banks. These loans and the process of transferring Euros abroad are described in the paper I presented in Athens May 19 at the Emergency Economic Summit for Greece:

Under these circumstances it would be desirable (i.e. consistent with and/or required by a European desire to keep Greece in the Euro Zone while returning it to fiscal balance and sustainability over a reasonable, if somewhat longer, period of time) for Greece’s creditors to forgive some of the debt held by the ECB and IMF and to lower the structural fiscal surpluses initially required in a follow on program for the next few years (this latter element had already been offered by the creditors before the referendum). In short, by reducing Greece’s debt service payments and lowering its primary fiscal surplus, it would endure less “austerity.” Former Finance Minister Varoufakis actually proposed a sensible risk sharing form of refinanced Greek debt indexed to the economy’s economic performance. Creditors would do better than expected on their concessional loans if the economy performed better than forecast and would suffer losses if it did worse. This would give both sides a financial incentive to get the pace and balance of fiscal adjustment right (growth maximizing). While Europe’s political leaders sort out the details, the ECB should continue to provide liquidity credit to the extent that, and as long as, Greek banks can provide realistically valued collateral.

The purpose of these adjustments by the creditors should not and must not be to throw more good money after bad allowing a continuation of decades of corruption, rent seeking and government inefficiency. Long before it joined the Euro Zone, Greece suffered poor government services by a bureaucracy overstaffed by friends and supporters of the government in power at the time. Not receiving expected government services, many Greeks have decided not to pay for what they are not getting. Hence tax evasion and a large underground economy added to Greece’s deficits. Quoting from Bret Stephens’ July 6 column: “Greeks retire earlier and live longer than most of their eurozone peers, which means they spend close to 18% of GDP on public pensions, compared with about 7% in Ireland and 5% in the U.S…. As of 2010, Greek labor costs were 25% higher than in Germany. [As a result of internal devaluation since then, this is no longer true.] A liter of milk in Greece costs 30% more than elsewhere in Europe, thanks to regulations that allow it to remain on the shelf for no more than a week. Pharmaceuticals are also more expensive, thanks to the cartelization of the economy…. Greece wanted to be prosperous without being competitive. It wanted to run a five-star welfare state with a two-star economy. It wanted modernity without efficiency or transparency, and wealth without work. It wanted control over its own destiny—while someone else picked up the check.”

Changing this behavior by Greek governments and the Greek public will not be easy if it is possible at all. The still very strong support by the Greek public for keeping the Euro suggests a strong awareness of the need for some restraints and discipline of its government’s spending. But is the desire for a truly better deal (from their own government) strong enough to overcome the resistance of the entrenched and favored interests, who would lose from liberalizing the economy and cleaning up the patronage mess and tax non compliance, etc.? The best hope is the formation of a unity government that strongly endorses a well balance program of gradual further fiscal adjustment and the continuation of the structural reforms so badly needed. Close monitoring by the creditors of Greek compliance with its promises and the phasing of financial assistance tied to such performance benchmarks, is the IMF’s standard approach to enforcing compliance with the measures the government agrees to. There are risks in agreeing to a third program and risks in not doing so and thus Grexit.

Grexit, even with total default on all external debt, will surely force more austerity on Greece than would any program now contemplated, even before taking account of the almost certain collapse of all of Greece’s already “temporarily” closed banks. The Greek government will hardly be in a position to bailout its banks suffering a surge of non-performing loans. Depositor bail-ins will need to cut all the way into “insured” deposits. The pain will be largely felt only in Greece, and unfortunately mostly by the ordinary Greek citizen.

Crony capitalism and the Export Import Bank

An important and fundamental principle of the rule of law is that laws should have wide or universal applicability to everyone. This principle is generally violated when governments subsidize specific activities. These subsidize might take the form of tax breaks, loans at preferential interest rates or even grants to favored enterprises or activities. The Export Import Bank is a government program for granting such favors in the name of promoting exports.

If the EX-IM Bank only provided information to American firms that helped them satisfy foreign requirements for selling their products abroad or to connect with services available for marketing such produces—following the model of the Small Business Administration or the Agricultural Extension Services provided by many states—their continued existence might be defensible. However, like so many government intrusions into the private sector, it provides huge subsidize to a limited number of customers (about 30% of the total to Boeing to subsidize the sale of its planes to foreign carriers) at the expense of others. American carriers like Delta complain that EX-IM Bank subsidies to Boeing benefit their foreign competitors, who are able to buy Boeing planes more cheaply than they are. “The Airline Pilots Association of America estimates that the bank’s subsidizing of Boeing airline purchases abroad has forced our domestic airlines to cut about 7,500 jobs – decreasing the airline workforce by almost 2 percent.” (The Blaze, May 29, 2015)

While the cost of the EX-IM Bank to U.S. taxpayers is trivial, it is one more drop in the growing pond of crony capitalist connections to the government. Boeing moved its headquarters from Seattle, where most of its production was traditionally located, to Chicago and has diversified its production and suppliers around the country precisely to have more representatives in congress with an interest in its well being. Like many other large companies seeking government favors, it has hired key people from government such as Kevin Varney, former chief of staff at the Ex-Im during Obama’s first term. The stakes for Boeing are large so you can be sure it is spending a lot of money one way or another to protect its interests. This is the nature of crony capitalism, which gradually diminishes real market competition and chokes productivity.

Creating programs that grant favors also creates strong incentives for less subtle and more overt, traditional style corruption. “For example, Johnny Gutierrez, an Ex-Im Loan Specialist, pled guilty on April 22, 2015 of accepting up to $78,000 in bribes in return for recommending the approval of unqualified loan applications to the bank, among other misconduct. During this period, Ex-Im gave Gutierrez nearly a 20 percent pay hike and paid-out thousands in performance bonuses. “ (Adam Andrzejewski, Forbes, )

The Ex-Im Bank and dozens of programs like it are economically unsound and wasteful and politically corrupting. It and others like it should be killed when ever possible. Here is a rare case where congress can do good by doing nothing (i.e. by not renewing the Bank at the end of this month).

The Cayman Financial Review

I have three articles in the latest issue of the quarterly Cayman Financial Review, on whose editorial board I serve. The first is the Letter from the Editorial Board, which explores my thoughts on restoring more market discipline of bank risk taking rather than piling on more government regulations: The second is the second installment of The Kabul Bank Scandal series,–Part-II/   And the third is my review of Martin Wolf’s new book, “Shifts and Shocks.” If any of these topics interest you please click on its link.

The Asian Infrastructure Investment Bank – AIIB

Last evening CCTV, the China Central Television company, contacted me about an interview about the AIIB at 8:15 am the next morning (i.e., this morning). I have appeared on their Biz Asia show several times in the past. I agreed to the interview and they arranged for a car to pick me up at 7:15am. Due to a mistake in scheduling the car, it did not arrive in time to get to the studio. Rather than go back to bed I am writing this note to share with you what I would have said.


Frustrated with the slow pace of governance reform of the existing international financial institutions (IMF, World Bank, Asian Development Bank) in which China was under-represented in relation to its economic size, China began discussing the establishment of alternative institutions. The first was the New Development Bank of BRICS (Brazil, Russia, India, China, and South Africa) to be headquartered in Shanghai, China. The AIIB was launched with a signing ceremony in Beijing on October 24, 2014 that included, in addition to China, representatives from Bangladesh, Brunei, Cambodia, India, Kazakhstan, Kuwait, Laos, Malaysia, Mongolia, Myanmar, Nepal, Oman, Pakistan, the Philippines, Qatar, Singapore, Sri Lanka, Thailand, Uzbekistan, and Vietnam. It will focus on the development of infrastructure in developing countries in the Asian-Pacific region.

The United States, which has traditionally held the Presidency of the World Bank and on whose territory are housed the headquarters of both the World Bank and the International Monetary Fund, has been cool to these developments, which initially resulted in Australia, New Zealand, and European countries as well as the U.S. declining to join (as financiers). However, last week Britain’s Chancellor of the Exchequer, George Osborne, announced that the UK would join as a founding member and was quickly followed by Germany, France, and Italy. Australia and New Zealand are reconsidering their earlier lack of interest. If that weren’t embarrassing enough for the US, a US government official told the Financial Times, “We are wary about a trend toward constant accommodation of China, which is not the best way to engage a rising power.”

CCTV Interview

Early this morning I received the following email from CCTV.

“Hello Warren,

“This is Qingzhao from China24 program, CCTVNEWS. Thanks for joining our studio AIIB discussion. You will discuss with two more guests in Beijing studio. They are Mr Ding Yifan, senior fellow of the Institute of World Development under the Development Research Center of the State Council. And John Ross, Senior Fellow of Chongyang Institute for Financial Studies, Renmin University of China. He is also the former adviser of ex-London mayor Ken Livingstone.  Question 3 and Question 5 are for you, please take a look.

“Q1: The first question is for you, Mr Ding. So far, the number of countries that have joined or are in the process of joining as a founding member have surpassed 30…Talk to us about the tangible benefits to Europe and Asia as more nations from the EU want to join the AIIB.

“Q2: John, the UK, Germany, France and Italy ALL applying to join as founding members of the AIIB. What’s the attraction for western countries to join in?

“Q3: Warren, following now FOUR western European nations wanting to join the Asian Infrastructure Investment Bank…U.S. Treasury Secretary, Jack Lew is urging HIS country’s lawmakers to pass reforms of the International Monetary Fund. Will IMF reforms finally be pressured to pass and if so, impact on attractiveness of AIIB?

“Q4: Mr Ding, with more western countries applying to join the AIIB, some people have concerns that their participation will, to some extent, weaken China’s role in the system. What’s your take? What’s the possibility of some countries turning out to be a Trojan horse?

“Q5: Warren, Washington views the AIIB as a rival to the U.S. led World Bank and IMF, but China has said the AIIB will COMPLEMENT existing multilateral institutions. What’s your take on AIIB’s role?”

Had I made it to their studio I would have said the following:

Question 3: Secretary Lew has been trying to get the IMF reforms passed by the US Congress for several years. Ironically the US was very instrumental in pressuring European countries to reduce their representation on the IMF’s Executive Board in favor of increasing the representation of the BRICS and other emerging market countries, by bringing IMF member country quotas closer to those calculated on the bases of their economic size and share in world trade. Europe has long been over represented and the emerging market countries under-represented on this basis. The US voluntarily accepted a smaller quota than this formula would produce long ago (thus reducing its financial contribution as well as its vote) and the proposed new amendments would not further reduce the US quota share. Moreover, the proposed doubling of the IMF’s quota resources would not increase the US financial contribution. Rather it would convert the large loan from the US to the IMF made during the recent financial crises from a loan to a quota increase. Thus it is strange for the US now to hesitate to support these reforms. Given that the International Financial Institutions (World Trade Organization, IMF, and WB) that the US helped create are part of the new post World War II world order of global trade from which the US and other market economies have so benefited, this strange US behavior is extremely short sighted.

I would like to think that Congress would get around to approving these reforms independently from the threats posed by China’s new institutions. Virtually every other IMF member country has, but the US enjoys veto power by virtue of its large quota of 17.5% and the requirement that any amendments to the IMF Articles of Agreement must be adopted by members collectively with 85% of the quotas. The reality seems to be the other way around. China was pressured to create competing institutions because the US has failed so far to endorse governance reforms in the existing one.

Question 5: The AIIB is more of a rival to the Asian Development Bank than to the World Bank, and is no rival to the IMF, which does not make development loans, at all. China claims that the AIIB is a compliment rather than a rival to the other development banks. It will have the virtue of a clear and relatively narrow mandate; while the World Bank is all over the map. Voting membership by the UK, Germany, France, etc. should help ensure that its loans meet the standards set by the ADB and the WB. The US has maneuvered itself out of that possibility, not that Congress would ever approve the funds for it anyway. On the other hand, establishing a new institution will absorb a lot of time and other resources in developing its staff, procedures and facilities that would not have been necessary if China had contributed the same funds for the same purposes to the ADB. The traditional Japanese Presidency of the ADB, whose headquarters are in the Philippines, is likely to yield to new governance provisions in the future, giving China a shot at the Presidency, just as the American and European leadership of the WB and IMF are likely to yield in the future as well.

In short, this is all political and the US has played it poorly to say the least. In the past US leadership internationally, whether through the institutions it helped build or in other ways, has been welcomed and accepted because the US stood for principles others could embrace and promoted and applied them fairly. More recently, and I mean for the last decade or two, and certainly in the case of the IMF and AIIB, it is behaving more like the king on the mountain leading others to want to knock it off. This promotes neither the American nor the global community’s interests.