Economics of a Recession in the Making
Globally or locally, or both? Let’s see why seasoned analysts have greeted the new program with allusions to Lego-nomics, Alice in Wonderland, patent unrealism, obvious inconsistency and suchlike. Similar words were used in the economic press to describe the new program, which apparently nobody took seriously. Why is that so? In other words, why come up with an unrealistic and inconsistent set of predictions? The only take from this is the following: Exchange rate stability depends on Fed policies, the global recession outlook, sheer luck, and what not. In the end, it hangs in a balance. People don’t seem to have understood what happened last year. The message is clear: The economic vision is nothing more than the time-honored, old school reliance on construction and automotive, sectors that require cheap credit, sectors that can be incentivized in the old vein, sectors that don’t create catch-up growth, increase total factor productivity and so on. Politically speaking, the only take I gather from all this is that the sword of Damocles, i.e. early elections, will hang over Turkish polity. Oddly enough, Trump is also in peril. He can’t be easily impeached but who knows what the impact of the renewed impeachment initiative will be on the electorate next year?
Possible, but is it probable? Well, it may turn out to be very probable if the incumbent party loses a lot of political-economic terrain to newly-formed parties, especially Mr. Babacan. If this happens, the threshold barely maintained via the alliance with MHP can no longer be passed, and even together the ruling parties would lose the next elections. Obviously, no incumbent would choose to go to early elections at a moment when opinion polls suggest such an outcome, but if there is a political-economic earthquake-like event, another major currency shock or a large tail risk incurred in Syria, then early elections may become a distinct possibility. Clearly, the main tenets of the Turkish political landscape remain intact: party solidarity is lower than ideological sequential fidelity, economic voting applies via a convoluted cultural and ideological detour – but it applies nonetheless, etc. A shift not only at the margin of ‘swing voters’ but attaining larger portions of AKP voters can then be possible. CHP won’t benefit, but all other rightwing parties can. Ironically, the one true measure that would maintain the status quo lies in financial prowess, not in toying with ad hoc incentives or printing money or more public spending and what not.
That the Turkish financial system is bank-centered can be a blessing also. Mainly, toxic assets that have to be wiped out lie in bank balance sheets. By the same token, insolvent businesses would or could be eliminated; healthy enterprises can be financially assisted, possibly after take-overs occur. Shifting grounds and resorting to FX-denominated overseas funding quite heavily in order to close the savings gap rather than exuberant public spending led to a probability limit in about 15 years. True, the net public debt fell, but it was replaced by the rising current account deficit. True, the public savings went up, especially in the early 2000s, but the private sector borrowed instead. Trading one gap with another is no panacea for the set of structural problems the Turkish economy faces, however. Now it is the private sector that is the locus of not only a marked slowdown – stagnation perhaps or even worse - because the FX-denominated debt stock it has piled up over the last 1215 years is large and its open position is significant. Should we bail out at least some of the private enterprises? Should we let them go bankrupt, hoping that on the basis of cheapness they will be bought by (foreign) capital and expect that the new owners will act more rationally? Should we design a scheme whereby banks participate in their equities? Although the real estate and construction and energy sectors come to the forefront, the impact of a fast depreciating currency wasn’t or isn’t confined to them. The impact is widespread across sectors.
Ad hoc measures won’t deliver –and they are costly
So, would the government opt for a radical solution? By radical, I don’t mean anything unknown thus far. Be it labelled TARP-like or not isn’t the real issue here. Last year, one could easily come up with something like a new “Ankara approach”, but this wouldn’t be good etiquette now. Issuing bonds can provide us with a starting point. It may be a workable idea. Two rounds of superbonds, 6 months each, could translate the locus from liquidity to the P&L. When? Exactly in October last year. Now that there is a delay, the SPV would issue bonds for longer maturities, and dissolve itself in at least a few years –like a private equity. In case some firms pass on to banks as collateral because they couldn’t pay their debt at all, it could be better to lock them in an SPV – possibly run by the TMSF (SDIF – Savings Deposit Insurance Fund of Turkey) - and let them be taken over by a team of real
sector experts. As such, the capital adequacy of banks can be shored up against the incoming storm – if there is one of course, but this is likely. Genuine NPLs could be transferred to the P&L instead of being retained in the balance sheet, with a haircut of course. Or else they can be offset against SDIF premia. A further real economy benefit would show itself in unemployment figures because experts would decide to what extent lay-offs are required because such decisions are better made not by the current owners. FX debt should be consolidated under one center thereof. If everything goes well, owners can always reclaim their firms after they are cleaned and everything is netted off. In order to do all of these, government guarantees and a cash injection would be required in the very beginning. The Turkey Wealth Fund can deal with this; so, it can actually issue securities and participate to equities.
Another approach could be the establishment of a ‘bad bank’ and/or a REIT. Bankrupt firms’ credit collaterals would be transferred to the ‘bad bank’, other banks would accept a haircut, and the rest of the shares could be re-issued to the public. Banks need be financed via long-term bonds until the IPO or SPO is completed. Banks could also be allowed to participate directly to equity through debt-equity swaps. If they so choose, banks will have to inject capital before the swap. The extent of the haircut can be rendered dependent on the amount of capital injection; the more recapitalized a bank is the lower is the haircut. Hence, with a tripartite scheme, risk can be redistributed and the maturity can be re-extended. Of course, to be able to do any of this, a major macro program has to be designed and markets, both domestic and overseas, should accept it. That would or should bring in a large chunk of front-loaded FX loans. When the problem is a garden-variety balance of payments crisis or a standard fiscal deficit issue, what is to be done is almost clear. When the locus of the problem is the private sector itself, however, one needs a little bit more financial prowess. Can it be done? Yes, I believe. Will it be done? Probably not in the very short-run. Nevertheless, this is the only route via which (a) the government can win again; (b) the credit impulse can be restored at full speed.
Did similar measures truly help after 2008?
Yes, despite many a caveat, they did. They will help a lot here also. I start with a testimony of no lesser mortal than John Taylor testifying before the U.S. Senate (John B. Taylor, “Assessing the Federal Policy Response to the Economic Crisis”, Testimony before the Committee on the Budget, U.S. Senate, September 22, 2010). John Taylor had previously provided evidence on the fact that the Fed’s policy rate was kept too low for too long a period prior to the crisis compared to what the Taylor Rule had implied, and that as an indicator of cheap and ample USD liquidity provision this was one of the causes of the crisis. He picks up from there and claims the fiscal stimulus was too discretionary, sporadic and short-lived during the first phase. Taylor claims that, perhaps in a watered down ‘New Keynesian’ fashion, fiscal stimulus intending to jump-start personal consumption –checks sent to households and tax rebates - did not achieve that goal. Rather, disposable income rose, but did not spread to personal consumption effectively, vindicating thus life-cycle permanent income consumption models reminiscent of Robert Hall, 1978. Whatever recovery there was came from investments – including inventory changes - instead. Taylor clearly states, returning back to the early 2009 debates with Christina Romer and Jared Bernstein, that the impact of the fiscal package was rather limited, to a large extent because it was not public spending directly or through local governments, but consisted rather of a household spending jump-start stimulus that failed.
Taylor does not agree that monetary measures were that helpful at the time they were introduced either.The Fed’s early opening up of its balance sheet before Lehman – Bear Stearns is a case in point - and the TAF (Term Auction Facility) were rather harmful, but TARP and AMLF (Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility) were timely moves. The Fed’s mortgage backed securities purchase program (MBS) was also not that effective except its early announcement effect. Taylor does also reveal that such large balance sheet-driven moves shadow the independence of the Fed, an important political point that will be raised repeatedly in the future in my opinion. Taylor conjectures in the International Journal of Central Banking Conference hosted by BoJ on September 16-17, 2010 that, based on his own joint research with Johannes Stroebel (Stroebel, Johannes C. and John B. Taylor, 2009, “Estimated Impact of the Fed’s Mortgage-Backed Securities Purchase Program,” NBER Working Paper 15626, December 2009), the impact of the MBS program on mortgage rates was rather limited once controlled for prepayment and default risks. If we take this view as true, that is unorthodox monetary policies do not work, then we should come up with a politically inclined explanation of QE2. The 2007-2009 crisis has been different from the 1929 crisis in terms of its political implications because Democrats had largely enhanced their hold on both houses in the 1930s, but the Tea Party and all that suggest that this time it is the rise of the Republicans in more than ever a conservative mold that the world now witnesses. Same political conclusion applies. Should there be a political change it won’t be in the direction of CHP – center-left - but a few right or centerright parties – MHP, IYIP; Babacan’s new party if it effectively runs - in fact would benefit instead.