The US housing bubble in historical perspective

Blogger Barry Ritzholtz at The Big Picture presents a diagram with the long-term evolution of US housing prices according to the Case-Shiller index. The diagram shows the extreme overvaluation during the housing bubble that began in the late 90s and burst in 2007. The diagram also suggests that a further massive downward correction is unavoidable during the coming years.

Summers: A Stimulus Must Aim for Long-Term Results

Larry Summers, designated director of Barack Obama's National Economic Council, has published the first inside statement on Obama's fiscal stimulus package. The focus will be on investment:

Investments in an array of areas -- including energy, education, infrastructure and health care -- offer the potential of extraordinarily high social returns while allowing our country to address some long-standing national challenges and put our economy on a solid footing for years to come. more...

The stimulus package is supposed to create 3 million new jobs:

... more than 80 percent of these 3 million jobs will be in the private sector, including emerging sectors such as environmental technology. This is a bold goal. But economists across the political spectrum recognize that it is far less risky to stand firmly against the forces propelling our economy downward than to be timid in the face of a mounting crisis. more...

For a skeptical view of the proposed stimulus package, see this entry in Greg Mankiw's blog with further links.

Schuldenverbot im Grundgesetz?

Hans-Jürgen Papier, Präsident des Bundesverfassungsgerichts, warnt in seinem heutigen Interview mit dem Hamburger Abendblatt vor einer fortwährenden Expansion der staatlichen Aufgaben und Ausgaben. "Wenn die Schuldenlast immer größer wird, geht insbesondere in Krisenzeiten die Lenkungs- und Gestaltungsfähigkeit des Staates verloren." Im Hinblick auf die aktuelle Finanz- und Wirtschaftskrise und das geplante schuldenfinanzierte Konjunkturpaket sagt er: "Die Begrenzung der Staatsverschuldung ist vom Bundesverfassungsgericht als ganz zentrale Aufgabenstellung bewertet worden. ... Das Ziel der Haushaltskonsolidierung sollte nicht aus den Augen verloren werden." Auf die Frage, welche Schuldenbremse er sich vorstellen könnte, antwortet er: "... etwa die Verankerung eines absoluten Schuldenverbots im Grundgesetz, das nur in wirklichen Notzeiten durchbrochen werden darf, gegebenenfalls mit qualifizierter Parlamentsmehrheit."

Dazu zwei Einwürfe (von ökonomischer Seite) zur Anregung einer Diskussion:

1. Die herrschende Meinung unter Ökonomen (= Mainstream-Ökonomie) sieht das anders; sie befürwortet, dass der Staat in der Krise genau nicht auf Haushaltskonsolidierung setzt, sondern sich antizyklisch verhält.
2. Auch die geltenden Regeln der EU (Stabilitäts- und Wachstumspakt) sehen vor, dass ein Staat im Falle einer schweren Rezession - die ja nach der gegenwärtigen prognostischen Gemengelage tatsächlich droht - von der Pflicht zur Wahrung eines ausgeglichenen Haushalts befreit ist.

A primer on quantitative easing ...

... on video at vimeo. This link has the imprimatur of Greg Mankiw. More video coverage of the financial crisis can be found at marketplace.org/financialcrisis.

Need more arguments against ZIRP?

Zero Interest Rate Policy (ZIRP) may be doomed to fail in stimulating a stumbled economy. The reason is that at zero rates financial intermediaries are not inclined or able to raise funds and to lend them out. But it is exactly this kind of business what the Fed needs to get the economy back on track. As the FT reports, ZIRP has taken money market funds hostage-perhaps the only remaining intermediaries that, until recently, continued to create market liquidity.

American Sonderweg?

While the European Union is working on tighter regulation of hedge funds (see previous post), the Federal Reserve will effectively start acting as a prime broker for them, as the Financial Times reports: Hedge funds gain access to $200bn Fed aid. For a critical discussion, see also the corresponding entry in the investment banker blog naked capitalism with further links.

Hedge funds' access to Federal Reserve credit will take place in the context of TALF, the Term Asset-Backed Securities Loan Facility. (Fed's Press Release on the new rules for TALF.) In opening TALF for hedge funds, the Fed will help them get the leverage they need for their business model. In effect, the Fed will help hedge funds to stay alive in an environment that has become increasingly hostile for them. More on hedge funds' problems in times of the credit crunch can be found in FAZ: Kampf um die Zukunft.

This brings me to my question: Why keep hedge funds alive with public funds? I say: Don't do it! Let them wither away and die a natural death. Let them become the dinosaurs of economic evolution. One less problem to worry about.

Commission launches public consultation on hedge funds

Today, the European Commission has launched a wide-ranging public consultation on hedge funds. It asks for views on problems such as systemic risks, market integrity and efficiency, risk management and transparency. The text of the consultation can be found here. This consultation must be seen in context with a resolution of the European Parliament of September 23, 2008, which has called for a tighter regulation of hedge funds and private equity. The resolution had been prepared by reports by Poul Nyrup Rasmussen and Klaus-Peter Lehne. It remains to be seen whether the activities of the Parliament and the Commission will result in a European hedge fund regulation.

Why does the ECB hesitate to further slash its policy rates?

The WSJ reports on differences between the Fed and the ECB: While the former is keen to drive Fed Funds Target Rate to zero, the Europeans are less inclined to further decrease policy rates - at least not as fast as they did since October. Incomprehension prevails about the ECB's apparent reluctance. But the Japanese experience taught us the following (BIS Working Paper No. 188). On page 16 the authors write:

Under the QEP [Quantitative Easing Policy], financial institutions have increased their dependence on the BOJ’s [Bank of Japan] money market operations as a means of adjusting their reserve balances. The financial institutions with a funds shortage have become more dependent on the BOJ’s funds-providing operations, while those with a funds surplus have come to use the BOJ’s funds-absorbing operations as a means of investing funds. Put differently, the BOJ has come to play the role of a money broker. This is the mechanism through which the BOJ has provided ample liquidity. However, when concerns over the financial system’s stability have receded and the precautionary demand for liquidity has declined, the BOJ has often faced difficulties in its attempt to supply liquidity. Specifically, it has experienced undersubscriptions in fund-providing operations: the total amount of bids have fallen short of the amount offered by the BOJ even at the lowest bidding interest rate of 0.001%.

More importantly:

As financial institutions have become more dependent on the BOJ’s money market operations, the size of the call market [...] has contracted further [...] This reduction in the size of the call market reflects lowered trading incentives for the following two reasons: first, the returns on investment in the call market have declined to a level that cannot cover trading costs [...]. Second, credit spreads have been narrowed substantially. A call rate of 0.001% means that the average of all borrowing rates is 0.001%, leaving little room for differences in rates between individual borrowers.

While the second reason may not hold under current conditions (credit spreads have substantially widened since Lehman), the first one is striking: when a central bank wants financial institutions to lend again to each other, policy rates at zero bound may be detrimental!

Econobloggers...

...are just about to change the way of policymaking. If someone looks for a good reason for blogging, see here.

Rescue Plan for American Automakers

The U.S. congress stands ready to bail out the auto industry by planning a series of loans to detroit carmakers. These loans are going to be associated with close government oversight to make sure that they will actually be used to reorganize the companies and to make them prepared for competition both in terms of costs and products. Nancy Pelosi, speaker of House of Representatives, said in a statement that “Congress will insist that any legislation include rigorous and ongoing oversight to guarantee that taxpayers are protected and that resources are directed to ensure the long-term viability and competitiveness of the American automobile industry.”

I merely wonder whether the U.S. officials are just about to declare that capitalism has failed. Those who are familiar with the reasons for the current misery in the U.S. auto industry may ask two questions: First, why did the industry not already take the required measures in recent years? Second, why has government to step in and to help the auto industry just in the mid of a financial crisis?

Maybe, answers can be found in Neo-Schumpeterian growth economics. To the first question: as long as the economy has boomed, marginal returns on investments in human capital intensive inventions, innovative and cost-reducing technologies have been small compared to those on investment in increasing capacity (for the simple reason that meeting the high demand in the boom is of first priority). To the second: When the economy stumbles and finds itself in a recession, the former kind of investment is more valuable than the latter one. Owing to dried up company-internal funding sources in these times, those investments have to be financed externally which is rather hard even in normal times because human capital is often not a good collateral for lending. But when there is also a financial crisis around, raising funds for those purposes is almost impossible.

While the second answer seems to be well-suited for the current problems in U.S. auto industry, one may still doubt that the answer to the first question is right.

Worried about the crisis? Have some inflation!

Two renowned US economists are arguing that inflation is the best way to combat the financial crisis. In their article on the webpages of the Peterson Institute for International Economics they argue that inflation (i) is preferable to deflation and (ii) in times of crisis has many advantages of its own. One of the advantages - according to them - is that inflation in the US induces a depreciation of the US dollar vis-à-vis the euro and thus effectively forces the ECB to engage in a more expansionary monetary policy (whereas in the case of a fiscal stimulus in the US the Europeans would free ride on the US expansion).

If this is a representative opinion among US economists then within the next few months we will see a huge fiscal expansion in the US (announced: fiscal stimulus of up to $700bn) accompanied by a massively expansionary monetary policy deliberately aimed at generating inflation.

My recommendation to the rest of the world: Tighten your seat belts!

PS: One of the two authors is Simon Johnson.

How (not) to combat a banking crisis

The Latvian authorities are testing a new approach to combat the financial crisis, as the Wall Street Journal reports: Overly pessimitic university teacher arrested. Honestly, I prefer the more traditional approach using monetary and fiscal policy. (Hier auf Deutsch)

A proposal to avoid deep recession

I am afraid to say this: We have to take Keynes‘ General Theory from our backmost shelf: Financial markets currently exhibit something similar to what Keynes told us is a liquidity trap. Not in a sense of people hoarding money but treasuries. The Fed has finally started to encounter this by a policy of quantitative easing inter alia by taking corrective actions directly in private credit markets.

The recent decline in treasury yields below 3 per cent does not incite private investors to put their money into firms. Given the uncertainty and gloomy prospects it is likely that firms do not want to raise a loan because there is no business to finance. Is that what Keynes called an investment trap?

What remains for policy makers to do about this misery? Taxes down, government expenditures up? Monetary policy? Given that Keynes is even right about effectiveness of economic policy in times of severe distress, lowering direct taxes will not work as private savings will simply eat them up without having any effect on interest rates (rates are already at historical lows). Other riskier investments than treasuries will not be made because of uncertainty and gloomy prospects. Even if savings finally find their way to banks, it is most likely that banks will put most of them into treasuries in order to clear their balance sheets at least as long as the financial crisis continues to hold.

In the light of its importance for economic activity, economic policy must do anything suited to foster consumption. For this we need a temporary and sharp reduction in the real interst rate that rapidly affects foremost consumption. Given dysfunctional financial markets, the traditional interest rate pass through from monetary policy instruments to consumption relevant interest rate is broken. Traditional monetary policy hence does not help. Only if central banks intervene directly in markets for private credit (what the Fed‘s new TARF instrument seems to aim at) one may expect a monetary impulse. This, however, can turn out badly in terms of allocative efficiency as it cannot be warranted that funds will flow where they are needed most. Effective fiscal policy seems more appropriate to boost consumption when it reduces value added tax or sale tax temporarily and surprisingly (admittedly, this proposal is in sharp contrast to what Taylor suggests) because that way the real interest rate that is directly relevant for consumption will decrease.

But there is a problem at least for continental Europe: price rigidity. It cannot be expected that firms will reduce prices in an instant when sale taxes fall even if competition is fierce. However, price rigidity also means that they will not increase simultaneously when consumption gains momentum.

What about this: At the end of, let say, each month, households can present their bills and receipts to fiscal authorities or tax offices to get allowances for their tax expenditures. For this being most effective, sale taxes are refundable in full and limited for one year.

IMF Working Paper - The Task Ahead

An interesting IMF Working Paper

IMF Working Paper
Research Department
The Tasks Ahead
Prepared by Olivier J. Blanchard
November 2008

Download

Vorträge im Rahmen des Graduiertenkollegs am 27. November in Jena

Das Graduiertenkolleg
„Global Financial Markets“
der Universitäten Jena und Halle-Wittenberg
lädt zu folgenden Vorträgen ein:

„The Current Financial Crisis: Iceland – A Case Study in Societal Collapse”
Jón Baldvin Hannibalsson
Finanz- und Außenminister Islands 1987-1995

„Die aktuelle Finanzkrise als Herausforderung für Ökonomie und Jurisprudenz“
Prof. Dr. Christoph Ohler, LL.M.
Friedrich-Schiller-Universität Jena

Zeit: 27.11.2008, 16:30 Uhr
Ort: Senatssaal, Universitätshauptgebäude, Universität Jena

Calls for Papers

Financial Markets and Portfolio Management, the quarterly finance journal published by the Swiss Society for Financial Market Research, has two very interesting Calls for Papers which I find fit very well in our program:

Regulation after the Crisis

Monetary Policy and Financial Markets

German loan guarantees for Adam Opel...

...might soon prove a huge mistake. Adam Opel, a German carmaker, has been heading for government loan guarantees in order to close its current liquidity gap (although it has been officially declared that this step is only a precautionary step and not a sign of Opel's financial weakness). German government says ready to help Opel.

But what is most likely to happen when government steps in? Will this measure calm financial markets? In a multinational corporation like GM, with the firm internal use of funds being hardly controllable or at least observable by financial markets, it is most likely that headquarters will abuse any additional dollar raised externally. In particular, anyone who is providing fresh funds to GM (or guarantees newly issued debt) will have to face the risk of huge losses in the case of bankruptcy, because of funds having been invested into almost intangible assets. And this danger is real -- given the enormous liabilities which GM has for example vis-a-vis its pensioners. Any dollar that is used to meet the pensioners' demands, though it may help GM in the short-run, could not be recovered in the case of bankruptcy.

Hence, either Opel has to be spun off first, or there is a fair amount of risk that the government will throw its money away by guaranteeing Opel's debt.

The summit labored ...

... and brought forth a joint declaration. The declaration - together with further information - can be found on the summit website of the White House. The first sentence reads:

We, the Leaders of the Group of Twenty, held an initial meeting in Washington on November 15, 2008, amid serious challenges to the world economy and financial markets.

Quite obviously this is a nod to another famous opening phrase: We the People This sets a high benchmark for the results that should be expected from the work agenda spelled out in the declaration.

Detailed analysis & discussion of the summit declaration will follow on these web pages.

Für eine deutsche Version bitte hier klicken: Der Weltfinanzgipfel kreißt ...

Call for papers - Finlawmetrics 2009

I just came across this interesting Call for Papers which some of us may be aware of...

http://portale.unibocconi.it/wps/allegatiCTP/call%20for%20papers%20071108.pdf

U.S. Does Not Support a Global Crisis Regulator

The New York Times reports on the preparations for the world financial summit in Washington on November 15. It becomes increasingly clear that no major decisions on changing the regulatory framework for financial markets can be expected from this summit. The Bush administration is opposed to this, while President-elect Obama clearly distances himself from the summit so as to avoid - according to the article - "being pinned down by commitments made by his predecessor". The article concludes by suggesting that the only concrete result that could be expected from the summit in the given situation is an agreement about a coordinated fiscal stimulus in the leading economies. This would be in line with the latest IMF recommendations.

PS: Dani Rodrik (Harvard) is critical vis-à-vis the current US stance.

EU urges reform of the IMF

According to EuropeanVoice.com, European leaders have agreed that the International Monetary Fund should be reformed to ensure that the institution is better able to anticipate future financial crises. Among other things, they agreed that developing countries should have a greater say in IMF decision making and that the Financial Stability Forum should be reformed and that its work should be better coordinated with the work of the IMF. While this is unequivocally positive, closer reading reveals the differences between member countries' positions. There are areas of agreement but there are other areas where the member countries agree to disagree. As a result, this European initiative will remain largely a French initiative and will be presented as such at the world financial summit in Washington on November 15 - which undoubtedly will reduce its effectiveness. If we combine this with the news that the President-elect will most likely not attend the summit, we come to the conclusion that no major policy decisions can be expected from this summit. Most likely any far-reaching reforms of the world financial system will have to wait until the new president takes office.  

DAX is going crazy due to VW

Last week has been unique in the history of Germany's most important stock exchange, Deutsche Börse. Although the shares of other companies were in free fall due to the financial crisis, the price of VW shares rose in the first two days of the week by 225% to more than 1000 Euro. This caused the DAX to raise instead to fall. As a consequence, Deutsche Börse was forced to change its rules, which now allow for an extraordinary diminution of a company's weight in the composition of the DAX. Although the reasons for the spectacular rise of VW shares have yet to be investigated, it seems that short sellers, especially hedge funds, needed to cover bets that had gone awry. There have been rumors that Porsche, the majority shareholder, itself has sold stocks to these funds. Legally speaking, this is a problem of “market abuse”. But has the market indeed been abused or have some market participants just bet on the wrong horse? And how much does an index need to be legally protected against transactions like these? It seems that these questions must be answered from an economic perspective.

Ph.D. Scholarships - Applications

Doctoral Fellowships - Post-Graduate Program
Fundamental Principles of Globalized Financial Markets – Stability and Change
The Ph.D. progamme "Fundamental Principles of Globalized Financial Markets – Stability and Change" is part of the research programme "Global Financial Markets" of the University Jena and the University Halle, Germany. The program initially offers 8 doctoral fellowships.
Candidates should have an excellent academic background and pursue a Ph. D. in the above mentioned fields of research, linking law and economics. Applications from abroad are welcome. The post graduate programme offers an interdisciplinary, four semester study program in German and English examining the current questions of international financial markets. Active participation as well as attendance in the research study program in Jena and Halle is expected from the candidates. The financial grant amounts to 1.150 Euro per month for 3 years maximum. Applications with the usual personal and academic record (vita, certificates, academic publications) have to be electronically submitted to both spokesmen of the post-graduate programme.
Prof. Dr. Christoph Ohler, LL.M. Rechtswissenschaftliche Fakultät Friedrich-Schiller-Universität Jena Carl-Zeiss-Str. 3 D-07743 Jena christoph.ohler@recht.uni-jena.de
Prof. Dr. Christian Tietje, LL.M. Juristische und Wirtschaftswissenschaftlich Fakultät Martin-Luther-Universität Halle Universitätsplatz 5 D-06099 Halle (Saale) christian.tietje@jura.uni-halle.de
Application has to be received by 31. March 2009.

Vortrag Prof. Pohl zur Finanzmarktkrise

Am 23. Oktober 2008 hielt Prof. Dr. Rüdiger Pohl, Wirtschaftswissenschaftlicher Bereich der Juristischen und Wirtschaftswissenschaftlichen Fakultät der MLU und ehemals Direktor des Instituts für Wirtschaftsforschung Halle (IWH), am Institut für Wirtschaftsrecht der MLU einen Vortrag zum aktuellen Thema “Aus der Balance – Die Krise an den Finanzmärkten”. Die Audioaufnahme des Vortrags sowie Materialien sind hier verfügbar:

• Audioaufnahme (RealMedia streaming)
• Audioaufnahmen (mp3 zum download - rechte Maustaste, speichern unter)
• PowerPoint-Folien