Tag Archives: Financial crisis

Updates from Chicago Booth

How sales taxes could boost economic growth
By Dee Gill – The fight against sluggish global economic growth has been expensive, protracted, and unexpectedly vexing, leaving central bankers in developed economies with a laundry list of shared frustrations. Meager economic growth, flagging wages, and low inflation persist, in spite of bankers’ monetary stimuli, and threaten to quash upward mobility for young job seekers and midcareer employees in even the richest countries.

There’s a poster child for what countries do not want to become: Japan. The former economic powerhouse has been stuck in low-growth purgatory since 1991. And yet, as much as they’d like to avoid it, some countries have been sliding in that direction.

Many big economies are stagnating, and economists are running out of options to fix them. The conventional monetary policy for encouraging spending has been to drop short-term interest rates. But with rates already near, at, or below zero, that method is all but exhausted. Some economists have also started to empirically and theoretically question the power of forward guidance, in which central banks publicize plans for future interest-rate policies, at the zero lower bound.

Central banks and governments badly need a new stimulus tool, preferably one that doesn’t cost a lot of money. Some researchers are proposing a fix that might sound unappetizing: raising sales taxes as a means of jump-starting economic growth.

Francesco D’Acunto of the University of Maryland, Daniel Hoang of Germany’s Karlsruhe Institute of Technology, and Chicago Booth’s Michael Weber find evidence that a preannounced tax hike—a 3-percentage-point increase in Germany’s Value Added Tax enacted in 2007—provided just the kind of growth stimulus central banks desperately need today. more>

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Updates from Chicago Booth

Given an out, people still fall back into debt
Research finds that keeping people out of debt traps isn’t as simple as paying off their loans
By Dee Gill – To the frustration of financial counselors everywhere, millions of people doom themselves to perpetual debt by repeatedly taking out small but expensive short-term loans they can barely afford. In the United States, these typically come from payday or car title lenders and go to financially strapped individuals.

In developing countries, small-scale entrepreneurs rely on daily or weekly loans for working capital. In both cases, borrowers pay exorbitant interest rates and, often, additional fees to extend a loan over and over. Interest payments can quickly add up to more than the loan amount.

Understanding how people get sucked into these debt traps is an important public-policy issue, according to Northwestern’s Dean Karlan, Chicago Booth’s Sendhil Mullainathan, and Harvard’s Benjamin N. Roth.

They conducted a series of experiments with indebted entrepreneurs in India and the Philippines and find that having their short-term loans paid off took the participants out of debt only temporarily. The entrepreneurs in question quickly took out new, profit-sapping loans. more>

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Hedge funds assets plunged by $88 billion in 2018

By Matt Egan – The hedge fund industry suffered a brutal 2018 as nervous clients yanked tens of billions of dollars from their portfolios. Hundreds of funds shut down and bets on tech stocks and oil blew up.

Hedge fund assets under management plummeted by $88 billion last year, according to research by eVestment, a firm that provides software to institutional investors. It was easily the deepest decline in assets for the industry since the financial crisis a decade ago, eVestment said in a report published.

Extreme turbulence across financial markets exposed glaring performance issues that have dogged hedge funds for years.

“Investors were again reminded that the industry is not necessarily full of exceptional managers,” wrote Peter Laurelli, eVestment’s global head of research. “There is no disputing the numbers.”

That realization hit a crescendo last month, when the S&P 500 suffered its steepest December decline since the Great Depression.

Jittery clients pulled $19.6 billion out of hedge funds that month alone, lifting annual withdrawals to $35.3 billion, eVestment said. more>

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Hedge funds

Debunking Deregulation: Bank Credit Guidance and Productive Investment

Deregulated banking in rich countries delivers more “investment” in speculative asset markets, not productive businesses.
By Josh Ryan-Collins – Mortgage and other asset-market lending typically does not generate income streams sufficient to finance the growth of debt. Instead, the empirical evidence suggests that after a certain point relative to GDP, increases in mortgage debt typically slows growth and increase financial instability as asset prices rise faster than incomes.

These new empirical findings support a much older body of theory that argues that credit markets, left to their own devices, will not optimize the allocation of resources.

Instead, following Joseph Schumpeter’s, Keynes’ and Hyman Minsky’s arguments, they will tend to shift financial resources away from real-sector investment and innovation and towards asset markets and speculation; away from equitable income growth and towards capital gains that polarizes wealth and income; and away from a robust, stable growth path and towards fragile boom-busts cycles with frequent crises.

This means, we argue, there is a strong case for regulation, including via instruments that guide credit. In fact, from the end of World War II up to the 1980s, most advanced economy central banks and finance ministries routinely used forms of credit guidance as the norm, rather than the exception. These include instruments that effected both the demand for credit for specific sectors (e.g. Loan-to-Value ratios or subsidies) and the supply of credit (e.g. credit ceilings or quotas and interest rate limits).

In Europe, favored sectors typically included exports, farming and manufacturing, while repressed sectors were imports, the service sector, and household mortgages and consumption. Indeed, commercial banks in many advanced economies were effectively restricted from entering the residential mortgage market up until the 1980s. Public institutions — state investment banks and related bodies — were also created to specifically steer credit towards desired sectors. more>

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>

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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>

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Why are millennials burned out? Capitalism.

BOOK REVIEW

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>

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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>