Tag Archives: Financial crisis

Updates from Chicago Booth

Financial contagion spreads through supply chains
By Michael Maiello – As big financial institutions such as Lehman Brothers fell into distress in 2008, a credit contagion spread through the financial industry, creating a credit drought for the economy as lenders retrenched and hoarded capital.

It has been less clear how credit contagion can spread through other industries, but research by George Washington’s Şenay Ağca, Georgetown’s Volodymyr Babich, Chicago Booth’s John R. Birge, and City University of Hong Kong’s Jing Wu suggests that credit shocks follow the supply chains of distressed companies.

Ağca, Babich, Birge, and Wu examined daily changes in credit default swap (CDS) spreads for all contracts with a five-year maturity between 2003 and 2014. A CDS is a derivative contract guaranteeing the owner a payout in the event that the borrower defaults. The contract’s price is known as the spread, which is the cost to insure against the default of $100 of the issuer’s debt. A widening spread signals that the market believes the issuer is more likely to default. Because the CDS market is deep and liquid, with information priced rapidly into the spread, the researchers argue that it is a better indicator of default expectations than laggard credit ratings or notes from bond analysts.

Take Ford Motor Company’s November 2008 earnings report, which highlighted massive losses, looming layoffs, and drastic cuts in capital spending. The CDS spreads linked to the company’s debt quickly widened, as one might expect. CDS spreads of American Axle & Manufacturing, a major Ford supplier, did the same, the researchers find. It makes sense that if Ford was slashing spending, its suppliers would have been suffering, they note.

But by contrast, CDS spreads were unchanged for companies with no relationship to either Ford or American Axle, such as semiconductor manufacturer Advanced Micro Devices. This suggests the mechanism by which contagion spreads is based on quantifiable business relationships, the researchers find. more>


How Adam Smith became a (surprising) hero to conservative economists

By Glory M Liu – People like to fight over Adam Smith. To some, the Scottish philosopher is the patron saint of capitalism who wrote that great bible of economics, The Wealth of Nations (1776). Its doctrine, his followers claim, is that unfettered markets lead to economic growth, making everyone better off. In Smith’s now-iconic phrase, it’s the ‘invisible hand’ of the market, not the heavy hand of government, that provides us with freedom, security and prosperity.

To others, such as the Nobel prizewinning economist Joseph Stiglitz, Smith is the embodiment of a ‘neoliberal fantasy’ that needs to be put to rest, or at least revised. They question whether economic growth should be the most important goal, point to the problems of inequality, and argue that Smith’s system would not have enabled massive accumulations of wealth in the first place. Whatever your political leanings, one thing is clear: Smith speaks on both sides of a longstanding debate about the fundamental values of modern market-oriented society.

But these arguments over Smith’s ideas and identity are not new. His complicated reputation today is the consequence of a long history of fighting to claim his intellectual authority.

Smith’s first biographer, Dugald Stewart, deliberately portrayed him in the 1790s as an introverted, awkward genius whose magnum opus was an apolitical handbook of sorts. Stewart downplayed Smith’s more politically subversive moments, such as his blistering criticism of merchants, his hostility towards established religion, and his contempt for ‘national prejudice’, or nationalism. Instead, Stewart shined a spotlight on what he believed was one of ‘the most important opinions in The Wealth of Nations’: that ‘Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.’

Stewart’s biography (first delivered as an eulogy in 1793, then published in 1794 and 1795) appeared in the wake of major events that terrified British audiences: the French Revolution of 1789, the Reign of Terror that followed and the sedition trials that followed in both England and Scotland. As the British historian Emma Rothschild has shown, Stewart’s depiction of Smith’s ideas cherrypicked in order to imbue political economy with scientific authority. She writes that he wanted to portray political economy as ‘an innocuous, technical sort of subject’, to help construct a politically ‘safe’ legacy for Smith during politically dangerous times. Stewart’s effort marked the beginning of Smith’s association with ‘conservative economics’.

Smith would soon earn a reputation as the father of the science of political economy – what we now know as economics. more>

Was the Rise of Neoliberalism the Root Cause of Extreme Inequality?

Financial meltdown, environmental disaster and even the rise of Donald Trump – neoliberalism has played its part in them all.
By George Monbiot – Imagine if the people of the Soviet Union had never heard of communism.

The ideology that dominates our lives has, for most of us, no name. Mention it in conversation and you’ll be rewarded with a shrug. Even if your listeners have heard the term before, they will struggle to define it. Neoliberalism: do you know what it is?

Its anonymity is both a symptom and cause of its power. It has played a major role in a remarkable variety of crises: the financial meltdown of 2007‑8, the offshoring of wealth and power, of which the Panama Papers offer us merely a glimpse, the slow collapse of public health and education, resurgent child poverty, the epidemic of loneliness, the collapse of ecosystems, the rise of Donald Trump. But we respond to these crises as if they emerge in isolation, apparently unaware that they have all been either catalyzed or exacerbated by the same coherent philosophy; a philosophy that has – or had – a name. What greater power can there be than to operate namelessly?

So pervasive has neoliberalism become that we seldom even recognize it as an ideology. We appear to accept the proposition that this utopian, millenarian faith describes a neutral force; a kind of biological law, like Darwin’s theory of evolution. But the philosophy arose as a conscious attempt to reshape human life and shift the locus of power.

Neoliberalism sees competition as the defining characteristic of human relations. It redefines citizens as consumers, whose democratic choices are best exercised by buying and selling, a process that rewards merit and punishes inefficiency. It maintains that “the market” delivers benefits that could never be achieved by planning.

Attempts to limit competition are treated as inimical to liberty. Tax and regulation should be minimized, public services should be privatized. The organization of labor and collective bargaining by trade unions are portrayed as market distortions that impede the formation of a natural hierarchy of winners and losers.

Inequality is recast as virtuous: a reward for utility and a generator of wealth, which trickles down to enrich everyone. Efforts to create a more equal society are both counterproductive and morally corrosive. The market ensures that everyone gets what they deserve. more>

Socialism: A short primer

By E.J. Dionne, Jr. and William A. Galston – Something new is happening in American politics.

Although most Americans continue to oppose socialism, it has reentered electoral politics and is enjoying an upsurge in public support unseen since the days of Eugene V. Debs.

The three questions we will be focusing on are: Why has this happened? What does today’s “democratic socialism” mean in contrast with past versions? And what are the political implications?

It’s worth recalling how important socialism once was at the ballot box to understand that this tradition has deeper roots in our history than many imagine. In the 1912 presidential election, Debs secured six percent of the popular vote, and Socialists held 1,200 offices in 340 cities, their ranks including 79 mayors.

The crash of 2008, rising inequality, and an intensifying critique of how contemporary capitalism works has brought socialism back into the mainstream—in some ways even more powerfully than in Debs’ time, since those who use the label have become an influential force in the Democratic Party.

Running as a democratic socialist, Sen. Bernie Sanders received 45 percent of the Democratic primary vote in 2016, and in the 2018 mid-term elections, members of Democratic Socialists of America were among the prominent Democratic victors. Their ranks included Alexandria Ocasio-Cortez, who quickly became one of the country’s best-known politicians.

The economic and financial collapse of 2008-2009 undermined the claim that the economy had entered a new era of stability and moderation. Experts who had preached the virtues of self-regulation were forced to recant. The slow recovery from the Great Recession left many Americans wondering whether they would ever regain the income and wealth they had lost. more>

We need to rethink our economic assumptions

By Isabel V. Sawhill – To defeat Trump in the upcoming election, Democrats are advancing a set of proposals engineered to excite their base: a single payer health system, college for all, a guaranteed jobs program.

All are worthy of debate but perhaps the problems go deeper. Perhaps they go to the core of our beliefs about how the world works, what makes the economy tick, and how this relates to human welfare.

The dominant paradigm right now is what is sometimes called Neoliberalism which I define as a belief in the efficiency of markets. Those on the left believe that a market economy needs more than a little help from government. There are social costs and benefits that markets ignore; economic downturns are not self-correcting; and a lack of competition or transparency can harm consumers.

By addressing these and other shortcomings, government can free the market to do what it does best. Still, the central belief is that markets are the most efficient way to organize a society and by extension optimize individual freedom.

Critics of this paradigm note that it is fundamentally flawed. Human beings are not just consumers, they don’t always behave rationally, and they don’t always maximize their own well-being. They need a sense of community, they care about the welfare of others, and their sense of what matters goes well beyond a larger GDP. They respond not just to economic incentives but to the desire for respect from their peers, to social norms, and to moral or religious principles.

There is an efficient allocation of resources to go with every possible allocation of dollar votes and the distribution of dollar votes should be a communal decision arrived at by democratic means.

At the core of the neoliberal theory – arguably its most influential precept — is the idea that people are paid what they are worth.

If incomes are unequal it’s because skills and talents are unequal. The rich deserve their riches because, for the most part, they earned them. The poor lack income because they have too little education or the other skills needed to get ahead.

There is a lot that’s ignored in the wages equal marginal productivity equation: the asymmetry of bargaining power, the difficulty of discerning who contributes what, the stickiness of established wage norms and employment relationships, and the lack of competition. more>

Capitalism is failing. People want a job with a decent wage – why is that so hard?

By Richard V. Reeves – Before capitalism, there was work. Before markets, before even money, there was work. Our remotest ancestors, hunting and gathering, almost certainly did not see work as a separate, compartmentalized part of life in the way we do today. But we have always had to work to live. Even in the 21st century, we strive through work for the means to live, hence the campaign for a “living wage.”

As a species, we like to define ourselves through our thoughts and wisdom, as Homo sapiens. But we could as easily do so through the way we consciously apply effort towards certain goals, by our work – as Homo laborans. It nonetheless took two revolutions, one agricultural, one industrial, to turn “work” into its own category.

Industrial capitalism sliced and diced human time into clearly demarcated chunks, of “work” and “leisure”. Work was then bundled and packaged into one of the most important inventions of the modern era: a job. From this point on, the workers’ fight was for a job that delivered maximum benefits, especially in terms of wages, in return for minimum costs imposed on the worker, especially in terms of time.

For Karl Marx, the whole capitalist system was ineluctably rigged against workers. Whatever the short-run victories of the trade unions, the capitalist retained the power; the ultimate control, over workers’ time. And the worker would remain forever alienated from their work. The goal was to assert sovereignty over our own time, free of the temporal control of the capitalist, able “to hunt in the morning, fish in the afternoon, rear cattle in the evening, criticize after dinner.”

The problem of alienation is far from solved. more>

Inequality: from redistribution to predistribution and beyond?

Soaring income inequality inevitably raises discussion of more progressive taxation. But a more fundamental focus on the ownership of capital is needed.
By Liam Kennedy – The now much-traveled line from the historian Rutger Bregman at Davos 2019 is a perfect encapsulation of the Zeitgeist: inequality is out of control, we know more or less how to reduce it but, instead of actually doing anything, here we are pretending to be baffled by the state of the world.

Outside those snow-capped peaks, there is, of course, widespread recognition of the need to tackle spiraling inequality. The Organisation for Economic Co-operation and Development has spoken about it, the International Monetary Fund has written about it and reducing inequalities is enshrined in the United Nations Sustainable Development Goals.

Unfortunately, this evidence does not always translate into coherent political action. In the United Kingdom, for example, top rates of income tax have become less progressive over the decades while corporation tax has been consistently cut since 2010. Acknowledging the inequality problem is a crucial first step—but there is also a strong case for looking beyond ‘taxes, taxes, taxes’ if it is to be truly tackled.

Additionally, UK income-inequality statistics are plagued with problems which militate against any consistent understanding of how much income those at the very top of the distribution are actually ‘earning’.  To put it bluntly, the rich are even richer than we realize.

The truth is that the initial fall in income inequality seen after the financial crisis was an aberration which has allowed the government to mask the more systemic and continuing rise in inequality the UK has experienced since the late 1970s. more>

Updates from Chicago Booth

Technology is splitting the job market
Some people are prospering, while others are left behind
By Raghuram Rajan – Soon, the smartphone may be replaced by a device implanted in our body that connects with our mind and provides instant access to both computing power and enormous databases. Computer-enhanced humans are no longer the realm of science fiction. The information and communications technology (ICT) revolution has fundamentally changed what we spend time on, how we interact with one another, what work we do and where we do it, and even how people commit crime.

Most importantly, it has upset the balance between the three pillars—the state, markets, and the community.

The ICT revolution has not just followed the course of previous revolutions by displacing jobs through automation; it has also made it possible to produce anywhere and sell anywhere to a greater degree than ever before. By unifying markets further, it has increased the degree of cross-border competition, first in manufacturing and now in services. Successful producers have been able to grow much larger by making where it is most efficient. This has created spectacular winners, but also many losers.

The technology-assisted market has had widely varying effects across productive sectors in a country. Some of the effects stem naturally from technological change, and some stem from the reactions of people and companies to it. Indisputably, it has raised the premium on human capabilities. As a result, some well-educated communities in big cities have prospered, while communities with moderately (typically high-school-) educated workers in semirural areas dominated by manufacturing often have not.

More generally, as with past technological revolutions, the need for people to adapt has come rapidly, before the benefits have spread widely. Indeed, the communities that are required to adapt the most, as always, are the communities that have been experiencing the greatest adversity, and have the least resources to cope. more>


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>


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>