Richard Clarida's retrospective on the financial crisis

October 24, 2010

I earlier discussed several of the presentations at the monetary policy conference at the Federal Reserve Bank of Boston last week. But missed in the popular coverage of the conference was an insightful discussion by Columbia Professor Richard Clarida that expressed very nicely the conclusions that I have come to as well on the events that led us into these problems.

Clarida wrote:

The subtitle of this paper is not 'I Told You So' and for a good reason. I didn't, and it wasn't because I was shy. Rather, as will be discussed later, I, like the vast majority of economists and policymakers, suffered-- in retrospect-- from Warren Buffet's 'lifeguard at the beach' problem: "you don't know who is swimming naked until the tide goes out"....
The efficient markets paradigm was seen as a working approximation to the functioning of real world equity and especially credit markets. The growing role of securitization in credit markets, especially in the US, was seen as a stabilizing innovation that reduced systemic risk by distributing and dispersing credit risk away from bank balance sheets and toward a global pool of sophisticated investors. While asset prices might well drift away from fundamental value and for long periods of time, 'bubbles' were difficult enough to identify ex ante so that the role for monetary policy was to limit collateral damage to inflation and economic activity when they burst....
It is startling to note in the US the chasm that emerged during the 'great moderation' between credit extended to the household and non-financial business sectors-- much of it through the 'shadow banking' system to be discussed below-- as compared against nominal GDP. This was the 'great leveraging' that accompanied the 'great moderation'....

Source: Clarida (2010; presentation slides)

Shadow bank liabilities versus traditional bank liabilities, in trillions of dollars. Source: Clarida (2010)

Clarida continued:

...greater and greater use of leverage which in turn supports asset prices which in turn support more leverage. And importantly, this channel is missing in the justly celebrated and influential Bernanke-Gertler model (1999) presented at Jackson Hole in 1999. In that model, the bubble affects real activity in two ways. First, there is a wealth effect on consumption, although that effect is presumed to be rather modest. Second, because the quality [of] firms' balance sheets depends on the market values of their assets rather than the fundamental values, a bubble in asset prices affects firms' financial positions and, thus, the premium for external finance. Although bubbles in valuations affect balance sheets and, thus, the cost of capital, B and G assume that—conditional on the cost of capital—firms make investments based on fundamental considerations, such as net present value, rather than on valuations of capital including the bubble. This assumption rules out the arbitrage of building new capital and selling it at the market price cum bubble-- the Ponzi finance stage of a bubble in the Minsky nomenclature.... "This time it was supposed to be different" because securitization and the expertise of the ratings agencies in assessing default risk correlations across various tranches of structured products was in theory supposed to make the financial system more stable and reduce systemic risk....
With the benefit of hindsight ... it seems clear-- at least to this author-- that the financial crisis and the credit and securitization bubble that preceded it resulted not only from spectacular failures in securities markets-- to allocate capital and price default risk-- but serious failures also as well by policymakers to adequately understand, regulate, and supervise these markets. Policymakers, academics, and market participants simply didn't know what they didn't know. They assumed that either it couldn't happen (after all, AAA securities 'never' default), or if it did, it would be systemically unimportant. Until the tide went out. But by then it was too late.

econbrowser.com

Ποιός έχει σειρά στην κρίση χρέους;

Ξεκίνησε ως χρηματοπιστωτική κρίση στις ΗΠΑ, εξελίχθηκε ως κρίση χρέους στην Ευρώπη και οδηγείται σε νομισματική κρίση στην Ιαπωνία. Το «κύμα» δείχνει ότι κινείται σε όλα τα γεωγραφικά μήκη και πλάτη του πλανήτη, με τους αναλυτές και ερευνητές να προσπαθούν να εκτιμήσουν ποιά θα είναι η συνέχεια.
Κι ενώ η πλειονότητα των αναλυτών φαίνεται να βλέπει μεσοπρόθεσμα, έρχεται ο διάσημος στρατηγικός αναλυτής της ιαπωνικής Wakabayashi FX Associates, Eishi Wakabayashi, να δείξει τις ΗΠΑ για δεύτερη φορά θύμα του «κύματος». Ο Eishi Wakabayashi, είχε προβλέψει και το 1995 ότι το γιεν θα φτάσει σε ιστορικά υψηλά έναντι του αμερικανικού νομίσματος, όπως άλλωστε και έγινε.

Ο Wakabayashi εξέφρασε στην ουσία τις ανησυχίες του για την πορεία του αμερικανικού ελλείμματος, γεγονός που θεωρεί ότι θα προκαλέσει πανικό στις αγορές, ενισχύοντας τις αποδόσεις των αμερικανικών ομολόγων και πιέζοντας εκ νέου το δολάριο χαμηλότερα. Φέτος, η μείωση σε ιστορικά χαμηλά των αποδόσεων των ομολόγων των ΗΠΑ, δείχνει ότι η οικονομία των ΗΠΑ έχει κερδίσει μέρος του momentum της. Ωστόσο, η μεγαλύτερη οικονομία του κόσμου θα ζήσει τη δικιά της κρίση χρέους από τον επόμενο Οκτώβριο μέχρι το 2012. Μάλιστα, βλέπει το δολάριο στα 74 γιεν μέχρι το Φεβρουάριο του 2012.
Τα πιο κοινά επιχειρήματα στην πιθανότητα αποσταθεροποίησης της οικονομίας των ΗΠΑ είναι: 1) η κινητοποίηση της ομοσπονδιακής κυβέρνησης των ΗΠΑ ενεργοποιώντας ένα ακόμα πακέτο βοήθειας τύπου TARP για τις αμερικανικές τράπεζες, 2) το γεγονός ότι η Ομοσπονδιακή Τράπεζα των ΗΠΑ προτίθεται να ανοίξει εκ νέου τις στρόφιγγες της ρευστότητας με την αγορά (και πάλι) κρατικών ομολόγων των ΗΠΑ, και 3) η δυνατότητα να τυπώνουν οι ΗΠΑ ένα νόμισμα στο οποίο αποτιμάται το χρέος της χώρας διεθνώς.
Το δημόσιο χρέος των ΗΠΑ επίσης από 37% του ΑΕΠ πριν την κρίση (οικονομικό έτος 2007) αναμένεται να διαμορφωθεί στο 60% του ΑΕΠ το 2010 σύμφωνα με τις προβλέψεις της Morgan Stanley (επίπεδα που υπολείπονται ιστορικά μόνο την περίοδο που ακολούθησε τον Β' Παγκόσμιο Πόλεμο), ενώ σύμφωνα με τις ίδιες προβλέψεις θα φθάσει το 87% του ΑΕΠ το 2020.

www.bankingnews.gr

Risky Business

The Chinese-goods tariff bill currently in Congress is a bad solution to the very real problem of the dollar's value.
Matthew Yglesias | September 30, 2010 | web only On Wednesday, the House of Representatives passed one of the last significant measures likely to be debated in the 111th Congress, a bill threatening to slap tariffs on Chinese-made goods unless China allows its currency to rise in value. The bill's prospects in the Senate are unclear, but it has its advocates, including New York's Chuck Schumer who complained Tuesday that the Obama administration's approach to the issue is nothing but "more talking … despite the fact that years of meetings and discussions with Chinese officials in an effort to persuade China to float its currency have repeatedly failed to produce lasting, meaningful results." As a political gesture, this is pretty good. The public wants to see action on unemployment. But job-creating "stimulus" has become unpopular, so a nice piece of legislation blaming foreigners for our problems makes a lot of sense. Even better, the currency-value issue is a real problem. Unfortunately, Congress' proposed solution is risky and unlikely to work. The good news is that there is a better way. It doesn't take a nation of billions to drive the value of the dollar down; we can and should do it ourselves. But first, what's the issue here? The issue is trade. Over the past 30 years, China has liberalized its economy substantially relative to the Mao-era baseline. That has vastly increased China's productive capacity -- up 7 percent to 10 percent per year each year. When Americans buy products that are produced in whole or in part in China, dollars are sent to China where they're exchanged for Chinese currency, the renminbi, which is used to pay Chinese people. And when Chinese people buy stuff from America, they first need to buy dollars with which to pay us. For years, the tendency has been for Americans to buy more stuff from China than China buys from America. That means that on net dollars are being exchanged for renminbi. What normally happens in a situation like that is the price of renminbi goes up relative to the price of dollars. That makes Chinese-made goods more expensive in America and American-made goods cheaper in China. Consequently, Americans buy less Chinese-made stuff, and Chinese people buy more U.S.-made stuff, and the trade flows balance out. But China, for a whole bunch of reasons, doesn't want to let its currency "float" on a free market. That means that to prevent the renminbi from getting too expensive, the country's central bank, the People's Bank of China, periodically buys up a bunch of American financial assets in order to keep the renminbi cheap. This ends badly for American manufacturers. If the renminbi were more expensive, Chinese people would have more purchasing power and would buy more American-made stuff. On the other hand, the portrayal of this as a situation in which China is "cheating" in the global trade game and stealing our jobs is both simplistic and inaccurate. Suppose the United States imposed a nationwide sales tax and then subsidized manufacturing companies with the revenues. People would see that as a regressive transfer to a narrow interest group and would wonder how our political system got so screwed up. Well, China's political system is not exactly the envy of the world. And keeping its money cheap is in effect a way of taxing the earnings of ordinary Chinese people in order to subsidize politically influential exporters. That doesn't mean Schumer's wrong that the cheap renminbi is bad for America, but it sets up a context that's more about mutual problems than assigning blame. The problem with the bill in Congress is that the proposed solution misses the mark. Threatening to slap high taxes on Chinese-made goods could cause the Chinese government to change its approach. By the same token, threatening to shoot a nuclear missile at Beijing could also produce such an effect. Or it might lead to a downward spiral of retaliation and recrimination that only makes things worse. At the end of the day, putting higher taxes on Chinese-made goods is only going to make things worse for American consumers and Chinese workers alike. The proposition that it will help U.S. manufacturers is based on the dubious notion that U.S.-China trade is mostly in identical goods. Realistically, the main consequences of a trade war would be Americans purchasing more stuff from countries that are similar to China (Vietnam, Bangladesh) while China buys more from Canada, Europe, and Japan. The good news is that there's a better way. The spectacle of the world's only superpower puzzling over the best way to reduce the value of our own currency is slightly bizarre. To be crude about it, you make dollars less valuable by having the Federal Reserve print more dollars, not by complaining to China. In technical terms, there are a number of ways you could achieve this. One is what's known as unsterilized foreign-exchange interventions. Another is Joe Gagnon's idea for bond purchases. The Fed can even print money and buy people's old socks with it. The point is that more dollars equals less valuable dollars. The result would be modest inflation in the United States -- which as Paul Krugman explains would be a good thing on its own terms. Then the only way for China to prop up the dollar would be to create ruinous inflation in its own country, which there would be no good reason to do. Problem solved. To get the results, Congress needs to focus attention on where the real problem is -- the Federal Reserve -- which has been too hesitant to act and whose board continues to face three vacancies thanks to the Senate's refusal to confirm Barack Obama's nominees. Admittedly, this doesn't pack the political punch of scapegoating foreigners. Unlike the tariff threat, though, it's overwhelmingly likely to work. And at the end of the day, voters will reward results. prospect.org