( δομή της διάλεξης μου στο London Greek Business Community και σύντομα στο American Institute of Diplomacy)
The Leggacy of the Economic Crisis:governmental hedonism and the next policymakers' mistake
- Chicago Schools New Theory(Fama, Cohrane,Thaler)
''Do not blame the efficient market hypothesis for the over- investment effect of the state and credit money injection! It wasn’t just housing bubble. Corporate investment was very high. All forms of investment were very high. Somewhere in the world people were saving a lot—the Chinese, for example. They were providing capital to the rest of the world. The U.S. was consuming capital like it was going out of sight''
Understanding the functioning of free economies
-how to preserve them,
- how to solve the problems that arise in them,
- how to capitalize on their strengths.
Current examples of false analysis for markets‘ crisis
Subrime market :
-Misguided Blame :government policy, not a failure of the market
-Act of 1999, also known as the Gramm-Leach-Bliley Act, blamed as a source of recent problems, but that act opened the door for financial firms to diversify:
-JPMorgan Chase could not have acquired Bear Stearns ,nor Bank of America(it is not the Act’s fault that the Fed
sweetened the Bear Stearns acquisition at taxpayer expense and forced Bank of America to acquire Merrill Lynch).
-Goldman Sachs and Morgan Stanley become bank holding companies when it became clear that they could no longer survive as investment banks
Origins of the Financial Crisis
-Unusual monetary policy moves and novel federal regulatory interventions.
-Poorly chosen public policies distorted interest rates and asset prices, diverted loanable
funds into the wrong investments, and twisted normally robust financial institutions into unsustainable positions
-Default rates on nonprime-mortgages rose to unexpected highs.
-Firms directly holding mortgages saw reduced cash flows. Firms holding securitized mortgage bundles (often called “mortgage-backed securities”) saw the expectation of continuing reductions in cash flows reflected in declining market values for their securities
-Countrywide Financial, the investment banks Lehman Brothers and Merrill Lynch, and the government-sponsored mortgage purchasers Fannie Mae and Freddie Mac, went broke or had to find a last-minute purchaser to avoid bankruptcy
The Federal Reserve Expands Credit
-From early 2001 until late 2006, the Fed pushed the actual federal funds rate below the estimated rate that would have been consistent with targeting a 2 percent inflation rate.1
-The demand bubble thus created went heavily into real estate. From mid-2003 to mid-2007, while the dollar volume of final sales of goods and services was growing at 5 percent to 7 percent, real estate loans at commercial banks were growing at 10–17 percent
-Credit-fueled demand pushed up the sale prices of existing houses and encouraged the construction of new housing on undeveloped land
Fanie Mae/Freddie Mac : state’s lovers
- 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low- and moderate-income borrowers.
-1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target—42 percent of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50 percent in 2000 and 52 percent in 2005.
-The hyperexpansion of Fannie Mae and Freddie Mac was made possible by their implicit backing from the U.S. Treasury.
- To fund their enormous growth, Fannie Mae and Freddie Mac had to borrow huge sums in wholesale financial markets.
Credit crisis or economic crisis ?
-to explain the decline in real estate prices we have to explain why they declined in places that didn’t have subprime mortgages !
Corporate Debt market :
- Modigliani-Miller world = zero transaction costs/leverage problem
( Suppose the government stepped aside and let these institutions fail. How long would it have taken to have unscrambled everything and figured everything out ? )
- A financial market in which failed enterprises like Freddie Mac or AIG are never shut down΄΄…. is like an American Idol contest in which the poorest singers never go home΄΄(Lawrence H. White)
-The closure of Lehman Brothers (and the near-closure of Merrill Lynch), by raising the interest rate that the market charges to highly leveraged investment banks, forced Goldman Sachs and Morgan Stanley to change their business models drastically
- The most effective and appropriate form of business regulation is regulation by profit and loss ?
Stock markets :
- stock returns went up to 60 % a year
( measure of volatility was running at about sixty per cent, non- effective and almost stupid to give credit ,STARTING FROM FANIE MAE/FREDIE MAC ,in those circumstances )
National Debts :
- Analysis of official Net Debt, % GDP and the Total net liabilities (on and off balance sheet), % GDP (2010 projections) for European Countries and USA
- The primary fiscal balances governments should be running in order to stabilise on-balance sheet debt to GDP ratios (% of GDP)
- Fiscal credibility gap – difference between required and actual primary surplus (% of GDP)
- Permanent fiscal contractions required to stabilise off-balance sheet liabilities (% of GDP)
Questions for the Policymakers
-How to use their formidable regulatory and supervisory powers to deal with various types of
potentially destabilizing prices inflation?
-How they should incorporate a view on asset prices into monetary policy decision making? ( it is NOT the Fed’s job to try and estimate the correct or fair value
for asset prices!)
- Can they have predictions for a bubble in all asset markets at the same time?
No easy answers to these old Questions
- the models used to assess the appropriate monetary policy are narrow and inflexible
- Where do we draw the line on what prices matter?)
Imbalances and Bubbles
-Policy makers have to distinguish between relative and absolute price movements, while also
linking broad price increases to money and credit expansion.
-we have to evaluate developments in key asset markets properly and quickly.
A new tool : Broad Price Index
-Prices from currently produced goods and services (both consumer and producer prices) as well as real and financial asset prices.
- Taylor rule, a guidepost for the official level of interest rates based on the standard consumer price measure vs Carson-Shen rule, an alternative measure of official rates.