Is the old Gillian Tett back? The one-time Financial Times capital market editor has taken to writing less frequently (understandable now that she has head the US operation) and less intrepidly (much of her commentary was prescient, particularly on my pet topic, collateralized debt obligations).
But her latest piece sounds a wee warning, and it’s one we’ve commented on as well, namely, that central banks are vulnerable to losses, and just like the banks they mind, may need a rescue by taxpayers if the err badly enough.
Her object lesson is the Swiss National Bank. Unlike most central banks, the SNB is quite transparent, and publishes periodic statements of the value of its assets on a mark to market basis. The usually conservative SNB made a uncharacteristically aggressive move last year, intervening in currency markets in an effort to suppress the value of its levitating franc.
Even though the locals applauded the move, the central bank was outgunned by currency traders and threw in the towel mid year. As the swissie continued to rise, the bank showed losses at the end of 2010 of SFr 21 billion. The only saving grace was that the gains on the bank’s hefty gold positions exceeded the damage. But that does not reassure its shareholders, who have become accustomed to annual payments out of bank “profits”, and are concerned that the profits this year will be too meager for them to enjoy their customary level of income.
The losses at the SNB have come to light partly because it is relatively transparent – and currency swings can be monitored more easily than, say, price moves on bonds. But the SNB is not the only central bank that has recently taken bold gambits. The European Central Bank, for example, holds an (ever-swelling) pile of periphery eurozone bonds; the Fed’s balance sheet has more than doubled in size, to $2,500bn, as it has gobbled up mortgage-backed bonds and Treasuries; and the Bank of England also holds a large pile of gilts and mortgage assets.
Thus far – unlike at the SNB – those experiments have not generated visible losses. A cynic might argue that is because there is less transparency. However, in reality, other central banks have also been canny – or lucky – too. The Fed, for example, acquired its mortgage assets at seemingly low prices, which creates a cushion. Last year the Bank of England saw unexpected gains on its gilt holdings and the ECB has recently enjoyed rising quantities of interest income from its peripheral bonds.
But this happy picture may not last indefinitely. In the coming years, the price of Treasuries or gilts could plunge; some peripheral eurozone bonds could even default, creating losses. If that ever occurred, some central bankers think that any pain could still be offset. The Fed, for example, currently receives so much “income” from seigniorage that it may have considerable room for manoeuvre. But, there again, the Fed already faces virulent domestic political criticism; and at the ECB there is no clear agreement about who would indemnify it in event of losses. It is not impossible to imagine a scenario, then, where losses might stir up a row; particularly if political groups already had an axe to grind – as in Switzerland.