Tag Archives: Financial crisis

Updates from Chicago Booth

What causes stock market crashes, from Shanghai to Wall Street
By Michael Maiello – The Shanghai Stock Exchange reached a historic peak in June 2015, and then plunged, losing almost 40 percent of its value in a month. This crash of the world’s second-largest stock market evoked comparisons to the 1929 Wall Street collapse, and provided a laboratory for testing an enduring explanation of its causes.

It has long been theorized that the 1929 crash reflected “leverage-induced fire sales,” according to University of International Business and Economics’ Jiangze Bian, Chicago Booth’s Zhiguo He, Yale’s Kelly Shue, and Tsinghua University’s Hao Zhou. They acknowledge that the theory has been well-developed to explain how excessive leverage makes investors sell in emergency conditions, accelerating market crashes. But they suggest that, until now, the empirical research has been lacking—and the China crash finally offers empirical evidence.

The researchers analyzed account-level data for hundreds of thousands of investors in China’s stock market. Because leverage was introduced in mainland China only in 2010, Bian, He, Shue, and Zhou were able to examine the implications of leverage-limiting regulations imposed in this decade. During the first half of 2015, there were two sources of leverage for Chinese investors—regulated brokerage houses and nonregulated online lending platforms. The latter, along with other nonbank lenders such as trust companies, formed the shadow-banking industry in China. The researchers thus studied the effects of each type of borrowing. more>


Updates from Chicago Booth

The safest bank the Fed won’t sanction – A ‘narrow bank’ offers security against financial crises
By John H. Cochrane – One might expect that those in charge of banking policy in the United States would celebrate the concept of a “narrow bank.” A narrow bank takes deposits and invests only in interest-paying reserves at the Fed. A narrow bank cannot fail unless the US Treasury or Federal Reserve fails. A narrow bank cannot lose money on its assets. It cannot suffer a run. If people want their money back, they can all have it, instantly. A narrow bank needs essentially no asset risk regulation, stress tests, or anything else.

A narrow bank would fill an important niche. Right now, individuals can have federally insured bank accounts, but large businesses need to handle amounts of cash far above deposit insurance limits. For that reason, large businesses invest in repurchase agreements, short-term commercial paper, and all the other forms of short-term debt that blew up in the 2008 financial crisis. These assets are safer than bank accounts, but, as we saw, not completely safe.

A narrow bank is completely safe without deposit insurance. And with the option of a narrow bank, the only reason for companies to invest in these other arrangements is to try to harvest a little more interest. Regulators can feel a lot more confident shutting down run-prone alternatives if narrow bank deposits are widely available. more>


Why are millennials burned out? Capitalism.


Kids These Days: Human Capital and the Making of Millennials, Author: Malcolm Harris.

By Sean Illing – What made millennials the way they are? Why are they so burned out? Why are they having fewer kids? Why are they getting married later? Why are they obsessed with efficiency and technology?

His answer, in so many words, is the economy. Millennials, Harris argues, are bearing the brunt of the economic damage wrought by late-20th-century capitalism. All these insecurities — and the material conditions that produced them — have thrown millennials into a state of perpetual panic. If “generations are characterized by crises,” as Harris argues, then ours is the crisis of extreme capitalism.

What Harris focused on is millennials as workers and the changing relationship between labor and capital during the time we all came of age and developed into people. If we want to understand why millennials are the way they are, then we have to look at the increased competition between workers, the increased isolation of workers from each other, the extreme individualism of modern American society, and the widespread problems of debt and economic security facing this generation.

Millennials have been forced to grow up and enter the labor market under these dynamics, and we’ve internalized this drive to produce as much as we can for as little as possible. That means we take on the costs of training ourselves (including student debt), we take on the costs of managing ourselves as freelancers or contract workers, because that’s what capital is looking for.

And because wages are stagnant and exploitation is up, competition among workers is up too. As individuals, the best thing we can do for ourselves is work harder, learn to code, etc. But we’re not individuals, not as far as bosses are concerned. The vast majority of us are (replaceable) workers, and by working harder for less, we’re undermining ourselves as a class. It’s a vicious cycle. more>

Updates from Chicago Booth

Viewing FICO scores spurs better financial habits
By Carla Fried – When it comes to financial matters, consumers tend to have a lot of confidence but a dearth of knowledge.

More than 400,000 customers of Sallie Mae, a private college-loan lender and servicer, were included in a study that tracked whether a quarterly email letting them know how to view their FICO score for free on Sallie Mae’s website might lead to better financial habits.

The FICO score is the ubiquitous financial report card businesses use to size up the creditworthiness of consumers.

Tatiana Homonoff, Rourke O’Brien, and Abigail Sussman find that Sallie Mae borrowers who received a quarterly email “nudge” were 65 percent more likely to log in to the website and view their FICO scores than customers who did not get the inbox prompt. Moreover, during the two-year study period that ended last June, participants who received the messages saw their FICO scores rise and were less likely to be delinquent in paying their bills. more>


But Can The Government Afford It?

By John T. Harvey – We’ve been hearing that a lot lately, being asked about things like the proposed U.S.-Mexico border wall, the possibility of universal health care, and even regarding existing programs like Social Security. It’s a relevant question, to be sure, but 99 times out of 100 (or maybe 999 out of 1000), the context in which it is placed is completely wrong.

I say this because the question is almost always asked regarding whether or not we have enough money. If there is one place where the economics discipline has most substantially let down the general public, it’s in explaining how the financial sector works.

Long story short: money is not a scarce resource. Labor is, oil is, clean water is. Money is not.

Money can be and is created with a keystroke, just as easily as I am typing these words. This is true in both the public and private sectors. The private sector creates brand new money every time someone takes out a loan.

It is a widespread belief that banks simply loan out people’s savings. Certainly that’s part of what they do, but only a very small part. Imagine if we really had to wait for people to save up enough cash for entrepreneurs to build restaurants, shopping centers, movie theaters, car dealerships, etc. Economic expansions would be very few and very weak.

Fortunately, that’s not what happens. Instead, when banks make loans, they simply create a deposit for the borrower out of thin air. Their only problem then is meeting the government’s reserve requirement. However, if the Federal Reserve wants to hit its interest rate target, it must supply those reserves (because if it doesn’t, banks will find themselves short of reserves which will drive up interest rates as they compete for them).

If the bank agrees that you have a clever idea, the money to fund it will be created. more>

Why Wall Street Isn’t Useful for the Real Economy

By Lynn Stout – In the wake of the 2008 crisis, Goldman Sachs CEO Lloyd Blankfein famously told a reporter that bankers are “doing God’s work.” This is, of course, an important part of the Wall Street mantra: it’s standard operating procedure for bank executives to frequently and loudly proclaim that Wall Street is vital to the nation’s economy and performs socially valuable services by raising capital, providing liquidity to investors, and ensuring that securities are priced accurately so that money flows to where it will be most productive.

The mantra is essential, because it allows (non-psychopathic) bankers to look at themselves in the mirror each day, as well as helping them fend off serious attempts at government regulation. It also allows them to claim that they deserve to make outrageous amounts of money.

According to the Statistical Abstract of the United States, in 2007 and 2008 employees in the finance industry earned a total of more than $500 billion annually—that’s a whopping half-trillion dollar payroll (Table 1168).

Let’s start with the notion that Wall Street helps companies raise capital. If we look at the numbers, it’s obvious that raising capital for companies is only a sideline for most banks, and a minor one at that. Corporations raise capital in the so-called “primary” markets where they sell newly-issued stocks and bonds to investors.

However, the vast majority of bankers’ time and effort is devoted to (and most bank profits come from) dealing, trading, and advising investors in the so-called “secondary” market where investors buy and sell existing securities with each other.

In 2009, for example, less than 10 percent of the securities industry’s profits came from underwriting new stocks and bonds; the majority came instead from trading commissions and trading profits (Table 1219).

This figure reflects the imbalance between the primary issuing market (which is relatively small) and the secondary trading market (which is enormous). In 2010, corporations issued only $131 billion in new stock (Table 1202).

That same year, the World Bank reports, more than $15 trillion in stocks were traded in the U.S. secondary marketmore than the nation’s GDP. more>

How a Decade of Crisis Changed Economics

By J. W. Mason – Has economics changed since the crisis?

As usual, the answer is: it depends. If we look at the macroeconomic theory of PhD programs and top journals, the answer is clearly, no. Macroeconomic theory remains the same self-contained, abstract art form that it has been for the past twenty-five years.

As Joan Robinson once put it, economic theory is the art of pulling a rabbit out of a hat right after you’ve stuffed it into the hat in full view of the audience.

Many producers of this kind of model actually have a quite realistic understanding of the behavior of real economies, often informed by firsthand experience in government. The combination of real insight and tight genre constraints leads to a strange style of theorizing, where the goal is to produce a model that satisfies the methodological conventions of the discipline while arriving at a conclusion that you’ve already reached by other means. It’s the economic equivalent of the college president in Randall Jarrell’s Pictures from an Institution:

About anything, anything at all, Dwight Robbins believed what Reason and Virtue and Tolerance and a Comprehensive Organic Synthesis of Values would have him believe. And about anything, anything at all, he believed what it was expedient for the president of Benton College to believe. You looked at the two beliefs, and lo! the two were one. more>

Updates from Chicago Booth

How poverty changes your mind-set
Understanding psychology may be key to addressing the problem
By Alice G. Walton – In a 2013 study published in Science, researchers from the University of Warwick, Harvard, Princeton, and the University of British Columbia find that for poor individuals, working through a difficult financial problem produces a cognitive strain that’s equivalent to a 13-point deficit in IQ or a full night’s sleep lost. Similar cognitive deficits were observed in people who were under real-life financial stress. Theirs is one of multiple studies suggesting that poverty can harm cognition.

But it was the fact that cognition seems to change with changing financial conditions that Chicago Booth’s Anuj K. Shah, along with Harvard’s Sendhil Mullainathan and Princeton’s Eldar Shafir, two authors of the Science paper, were interested in getting to the root of.

They suspected that poverty might essentially create a new mind-set—one that shifts what people pay attention to and therefore how they make decisions.

“Some say you really have to understand the broad social structure of being poor, and what people do and don’t have access to,” says Shah. “Others say that poor individuals have different values or preferences. We stepped back and asked: ‘Is there something else going on?’” more>


How Bronze Age Rulers Simply Canceled Debts

By Michael Hudson – My book And forgive them their debts”: Lending, Foreclosure and Redemption from Bronze Age Finance to the Jubilee Year  is about the origins of economic organization ad enterprise in the Bronze Age, and how it shaped the Bible. It’s not about modern economies. But the problem is – as the reviewer mentioned – that the Bronze Age and early Western civilization was shaped so differently from what we think of as logical and normal, that one almost has to rewire one’s brain to see how differently the archaic view of economic survival and enterprise was.

Credit economies existed long before money and coinage. These economies were agricultural. Grain was the main means of payment – but it was only paid once a year, at harvest time. You can imagine how awkward it would be to carry around grain in your pocket and measure it out every time you had a beer.

We know how Sumerians and Babylonians paid for their beer (which they drank through straws, and which was cleaner than the local water). The ale-woman marked it up on the tab she kept. The tab had to be paid at harvest time, on the threshing floor, when the grain was nice and fresh. The ale-woman then paid the palace or temple for its advance of wholesale beer for her to retail during the year.

If the crops failed, or if there was a flood or drought, or a military battle, the cultivators couldn’t pay. So what was the ruler to do? If he said, “You owe the tax collector, and can’t pay. Now you have to become his slave and let him foreclose on your land.”

Suddenly, you would have had a slave society. The cultivators couldn’t serve in the army, and couldn’t perform their corvée duties to build local infrastructure.

To avoid this, the ruler simply cancelled the debts (most of which were owed ultimately to the palace and its collectors). The cultivators didn’t have to pay the ale-women. And the ale women didn’t have to pay the palace.

All this was spelled out in the Clean Slate proclamations by rulers of Hammurabi’s dynasty in Babylonia (2000-1600 BC), and neighboring Near Eastern realms. They recognized that there was a cycle of buildup of debt, reaching an unpayably high overhead, followed by a cancellation to restore the status quo ante in balance.

This concept is very hard for Westerners to understand. more>

Is a Recession Coming?

By Derek Thompson – Cascading stock prices might seem like a random crisis if you’ve been paying attention to the overall economy, which is booming. At 3.7 percent, the official unemployment rate is the lowest of this century. Job satisfaction is at its highest level in more than a decade. Small-business and consumer confidence hit record highs this year.

Observing the gap between Wall Street jitters and Main Street optimism, some are inclined to point out that “the stock market is not the economy.” But you should resist that temptation. The stock market is not the entire economy. (Neither is wage growth or health-care spending.) Rather, the stock market is a part of the economy that reflects both the value of capital investment in public companies and a prediction of their future earnings. As labor costs increase (good news for workers), and interest rates creep up (good news for traditional savings accounts), cost of business increases for many large companies, which can hurt their stock value.

For many years, corporate profits thrived as labor costs were low. Now corporate profits are at risk as labor costs are rising.

One way to predict the likelihood of a recession today is to look back at the past few downturns and evaluate whether the U.S. economy is in danger of repeating history. more>