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Friday, April 21, 2023Friday, April 21, 2023 11
Understanding the Financial CrisisUnderstanding the Financial Crisis Presentation toPresentation to
Students & Friends of Rensselaer HartfordStudents & Friends of Rensselaer HartfordHartford, CTHartford, CT
James Stodder, (Ph.D., Economics, Yale 1990)Lally School of Management & Technology
Rensselaer Polytechnic Institute at HartfordHartford, Connecticut, USA
Outline of TalkOutline of Talk
1.1. Keynes on Credit Cycles: Keynes on Credit Cycles: - Why we need Regulation- Why we need Regulation
2.2. Where is the Bottom?Where is the Bottom?
3.3. Connecticut is “Middle of the Pack”Connecticut is “Middle of the Pack”
4.4. Government Deficit SpendingGovernment Deficit Spendinga.a. Needed in the Short-termNeeded in the Short-term
b.b. But a Big Problem Long-termBut a Big Problem Long-term
Friday, April 21, 2023Friday, April 21, 2023 22
(1) Biz & Credit Cycles (1) Biz & Credit Cycles J. M. Keynes: 1883-1946J. M. Keynes: 1883-1946
Friday, April 21, 2023Friday, April 21, 2023 33
Friday, April 21, 2023Friday, April 21, 2023 44
US Macro-Stability: US Macro-Stability: Better, Room for Improvement Better, Room for Improvement
Source: http://www.nber.org/cycles.html
45% 55%
66%34%
Bad News: Bubbles are Bad News: Bubbles are EndemicEndemic
Friday, April 21, 2023Friday, April 21, 2023 55
Arlington Williams, “Price Bubbles”www.indiana.edu/~arlwilli/pdf%20files/bigmkts.pdf
Good News: People Do LearnGood News: People Do Learn
Friday, April 21, 2023Friday, April 21, 2023 66
V. Smith & A. Williams, “Experimental Market Economics,” Scientific American, Dec. ‘92
The Wisdom of KeynesThe Wisdom of Keynes
Friday, April 21, 2023Friday, April 21, 2023 77
““A sound banker, alas, is not one A sound banker, alas, is not one who foresees danger and avoids who foresees danger and avoids
it, but one who, when he is ruined, it, but one who, when he is ruined, isis ruined in a conventional way,ruined in a conventional way, along with his fellows,along with his fellows, so that no so that no one can really blame him.” one can really blame him.”
- J.M. Keynes (1931)- J.M. Keynes (1931)
Friday, April 21, 2023Friday, April 21, 2023 88
“Paradox of Thrift” Keynes noted:
Consumers cut back on their spending and save more during a recession. This only makes the recession worse.
Similarly for Banks, Loan Loss Reserves (LLR) are often raised in a recession, just when households and businesses most need credit –ensuring more collapses and worsening the recession.
Insurance => Moral Hazard =>Insurance => Moral Hazard =>Necessity of Necessity of RegulationRegulation
Friday, April 21, 2023Friday, April 21, 2023 99
Moral HazardMoral Hazard of Insurance: of Insurance:
If you had a car that is less damaged If you had a car that is less damaged by any given car crash – would that by any given car crash – would that make you drive make you drive fasterfaster??
If you (and everybody else) drove If you (and everybody else) drove faster, could this actually wind up faster, could this actually wind up making you making you less safeless safe ? ?
Friday, April 21, 2023Friday, April 21, 2023 1010
www.nytimes.com/2008/10/03/business/03sec.html www.economist.com/finance/displaystory.cfm?story_id=12480887
Friday, April 21, 2023Friday, April 21, 2023 1111New Yorker, Oct. 2008
Limits of Fed MagicLimits of Fed Magic
Currency Rises SlightlyCurrency Rises Slightly
Friday, April 21, 2023Friday, April 21, 2023 1212
June 2010
But Bank Reserves up 100-foldBut Bank Reserves up 100-fold
Friday, April 21, 2023Friday, April 21, 2023 1313
Sept. 16, 2009 June 2010
M0 = Currency + Reserves ≈ $2.0tM0 = Currency + Reserves ≈ $2.0t
Friday, April 21, 2023Friday, April 21, 2023 1414
Sept. 16, 2009 June 2010
M1 ≈ $1.7t M1 ≈ $1.7t = Currency + Bank = Currency + Bank DepositsDeposits
Friday, April 21, 2023Friday, April 21, 2023 1515
July 2010
Money Multiplier = M1/M0 < 1Money Multiplier = M1/M0 < 1
Friday, April 21, 2023Friday, April 21, 2023 1616
July 2010
Bank Money MultiplierBank Money Multiplier
If If ll = % loans, Reserve multiplier is= % loans, Reserve multiplier is
D = R(1+D = R(1+ l + l l + l 22++… … + l + l ∞∞ ) )== R/(1- R/(1-
l l ))
If M0 = Reserves (R) + Currency (C),If M0 = Reserves (R) + Currency (C),
M1 (M1 (CurrencyCurrency + + DepositsDeposits) multiplier is:) multiplier is:
M1 = M1 = C C + + R/(1- R/(1- l l ) ) = = M0–RM0–R+ + R/(1- R/(1- l l ))
M1/M0 = 1+{M1/M0 = 1+{-R -R + + R/(1- R/(1- l l )}/M0)}/M0
So So M1/M0 < 1 M1/M0 < 1 => => l l < 0 < 0 Friday, April 21, 2023Friday, April 21, 2023 1717
The Zero BoundThe Zero Bound
Friday, April 21, 2023Friday, April 21, 2023 1818
June 2010
Friday, April 21, 2023Friday, April 21, 2023 1919
FISCAL Expansion: Investment Demand = Savings
interest rate FISCAL Expansion:
Money Demand = Supply
GDP
Keynes’s Liquidity Trap: Keynes’s Liquidity Trap:
Friday, April 21, 2023Friday, April 21, 2023 2020
Investment Demand = Savings
interest rate
Money Demand = Supply
GDP
FISCAL Expansion: Investment Demand = Savings
interest rate MONETARY Expansion:
Money Demand = Supply
GDP
Keynes’s Liquidity Trap: Keynes’s Liquidity Trap:
Friday, April 21, 2023Friday, April 21, 2023 2121
FISCAL Expansion: Investment Demand = Savings
interest rate FISCAL Expansion:
Money Demand = Supply
GDP
Keynes’s Liquidity Trap: Keynes’s Liquidity Trap:
Friday, April 21, 2023Friday, April 21, 2023 2222
FISCAL Expansion: Investment Demand = Savings
interest rate FISCAL Expansion:
Money Demand = Supply
GDP
Keynes’s Liquidity Trap: Keynes’s Liquidity Trap:
Output Gap ≈ 20% GDPOutput Gap ≈ 20% GDP http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-
Outlook_Testimony.pdfOutlook_Testimony.pdf
A little Stimulus Math:A little Stimulus Math:
20% * $14 tr. = $2.8 tr.20% * $14 tr. = $2.8 tr.
Stim*1.5 = $2.8 => Stim*1.5 = $2.8 => Stim = $1.87 tr.Stim = $1.87 tr.
Friday, April 21, 2023Friday, April 21, 2023 2323
(2) 3 (2) 3 ReasonsReasons Bottom still Bottom stillA Long Way OffA Long Way Off
Housing RecoveryHousing Recovery probably more probably more than a year away.than a year away.
Credit Markets Credit Markets still very weak.still very weak.
Stock Market Valuation Ratios Stock Market Valuation Ratios like like P/E and Tobin’s Q are now only at P/E and Tobin’s Q are now only at historical averages.historical averages.
Friday, April 21, 2023Friday, April 21, 2023 2424
HousingHousing BottomBottom – A Long– A Long WayWay OffOff
Friday, April 21, 2023Friday, April 21, 2023 2525
http://www.nytimes.com/imagepages/2008/10/16/business/16housing.graphix.ready.html
Friday, April 21, 2023Friday, April 21, 2023 2626
Why it Matters to EveryoneWhy it Matters to Everyone
Indicators of Credit CrisisIndicators of Credit Crisis
Friday, April 21, 2023Friday, April 21, 2023 2727
http://www.nytimes.com/interactive/2008/10/08/business/economy/20081008-credit-chart-graphic.html
0.00
0.50
1.00
1.50
2.00
2.50
3.00
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
TED-Spread & Financial CrisesTED-Spread & Financial Crises
Friday, April 21, 2023Friday, April 21, 2023 2828
S&L crisis
Subprimefinancialshock
Peso crisis
LTCM
TechbustOrange
County
Thai baht
Y2K
108 Years of P/E and Q108 Years of P/E and Q
Friday, April 21, 2023Friday, April 21, 2023 2929
Shiller/Smithers - www.ft.com/cms/s/0/099f6380-bb1f-11dd-bc6c-0000779fd18c.html
(3) CT is “Middle of the Pack”(3) CT is “Middle of the Pack”
Fairfield Financial Sector down, but ..Fairfield Financial Sector down, but .. Conventional Banking and Insurance Conventional Banking and Insurance
less vulnerable than Investment less vulnerable than Investment Banks, Financial InsuranceBanks, Financial Insurance
Defense industries well insulatedDefense industries well insulated Pharmaceuticals and Biotech have Pharmaceuticals and Biotech have
good long-term prospectsgood long-term prospects House Price Increases near US Avg.House Price Increases near US Avg.Friday, April 21, 2023Friday, April 21, 2023 3030
Friday, April 21, 2023Friday, April 21, 2023 3131
CT’s Largest Private Employers, CT payroll
•United Technologies Corp. (UTC) 26,490•The Stop & Shop Cos. Inc. 14,049•The Hartford Financial Services Group Inc. 13,000•Yale University 12,100•Foxwoods Resort Casino 11,900•Mohegan Sun Casino 10,000•U.S. Naval Submarine Base 9,900•Wal-Mart Stores, Inc. 9,038•AT&T Corporation 7,700•General Dynamics Electric Boat 7,500•General Electric Co. 7,500•Aetna Inc. 7,252•Pfizer Global Research and Development 7,000•The Travelers Cos. Incorporated 6,500•Hartford Hospital 6,377•Bank of America 5,100•Cigna 3,984•Northeast Utilities 3,947•Saint Francis Hospital and Medical Center 3,892•United States Surgical 3,800
Source: Economy.Com, Connecticut State Precis, Sept., 2008
COLOR KEYDefenseHealth & EducationInsurance & BankingCounter-cyclicalPro-cyclical
International Housing PricesInternational Housing Prices
Friday, April 21, 2023Friday, April 21, 2023 3232
Friday, April 21, 2023Friday, April 21, 2023 3333
More Stable than US as a WholeMore Stable than US as a Whole
Friday, April 21, 2023Friday, April 21, 2023 3333
US CT
100%91%
Fig. 3: Employment Volatility, US and CT
Source: Economy.Com, Connecticut Precis, Sept. 2008
State Income Growth ComparableState Income Growth Comparable
Friday, April 21, 2023Friday, April 21, 2023 3434
Source: Economy.com, CT Precis, Sept. 2008
State Unemployment ComparableState Unemployment Comparable
Friday, April 21, 2023Friday, April 21, 2023 3535
Source: Economy.com, CT Precis, Sept. 2008
Friday, April 21, 2023Friday, April 21, 2023 3636
Sun Belt, Rust Belt ConcentrationSun Belt, Rust Belt Concentration
Friday, April 21, 2023Friday, April 21, 2023 3737
CT Suffered Less than Most in NortheastCT Suffered Less than Most in Northeast
Friday, April 21, 2023Friday, April 21, 2023 3737
-4.8%
-2.9% -2.9%
-2.1%-1.7%
-1.4%
-0.8%
1.8%2.2%
RI NJ MA NH US CT NY VT ME
Fig. 2b: Annual Change in House Prices, 2007Q2-2008Q2
Source: Office of Federal Housing Enterprise Oversight: http://www.ofheo.gov/media/pdf/2q08hpi.pdf
What doesn’t go up too far, What doesn’t go up too far, Won’t go down so farWon’t go down so far
Friday, April 21, 2023Friday, April 21, 2023 3838
Economy.com, CT State Report, Sep. 2008
Friday, April 21, 2023Friday, April 21, 2023 3939
2006 Peak of Price-to-Rent2006 Peak of Price-to-Rent
4040
Friday, April 21, 2023Friday, April 21, 2023 4141
Source: NY Times, May 28, 2008; Economy.com
San Francisco Los Angeles
West Palm
Beach
Orange County
San Diego
Miam
i
Sacramento
Boston
New York
Fort Lauderdale
Orlando
St. Louis
San Jose
Las Vegas
Riverside-San Bernadino
Nassau-Suffolk
Oakland,
Phoenix
Washington
Tampa
-St.
UNITED STATES, 21.0
New O
rleans
Minneapolis
Jacksonville
Charlotte
Baltimore
Atlanta
Raleigh
HARTFORD, 18.2 Seattle
San Antonio
Portland
Chicago
Milw
aukee
Denver
Philadelphia
Houston
Salt Lake City
Oklahom
a
Mem
phis
Austin
Dallas
Cincinnati
Kansas City
Pittsburgh
Indianapolis
Columbus
17.5
17.4
10
15
20
25
30
35
40
45
Fig. 1c: Price to Rent Ratio, US MSAs, Peak to 2008, Q1
P/R Peak P/R 2008
Friday, April 21, 2023Friday, April 21, 2023 4242www.bos.frb.org
US Vacant Homes for Sale US Vacant Homes for Sale (thousands)(thousands)
Friday, April 21, 2023Friday, April 21, 2023 4343
1,000
1,250
1,500
1,750
2,000
2,250
00 01 02 03 04 05 06 07 08
Housing supply 900,000Single 525,000Multi 300,000Manufactured 75,000
Housing demand 1,400,000Households 875,000Obsolescence 400,000Second homes 125,000
Economy.com, Census, Nov. 2008
(4) More Federal Deficit Spending (4) More Federal Deficit Spending (not Tax Cuts) Necessary(not Tax Cuts) Necessary
Tax cuts to the rich more likely to be Tax cuts to the rich more likely to be saved, not spent or invested.saved, not spent or invested.
Tax cuts don’t have big effect on Tax cuts don’t have big effect on those too poor to pay many taxes.those too poor to pay many taxes.
Unmet needs in Energy, Environment, Unmet needs in Energy, Environment, Health, and Education: good reasons Health, and Education: good reasons to spend.to spend.
Friday, April 21, 2023Friday, April 21, 2023 4444
Government Must Government Must Increase Increase SpendingSpending in Severe Recession in Severe Recession
“ “ If the Treasury were to If the Treasury were to fill old bottles with fill old bottles with banknotesbanknotes, bury them at suitable depths in , bury them at suitable depths in disused coal mines …disused coal mines …
It would, indeed, be It would, indeed, be more sensible to build more sensible to build
houses houses and the like; but if there are and the like; but if there are political and practical difficulties in the political and practical difficulties in the way of this, the above would be better way of this, the above would be better than nothing.” than nothing.” (Keynes, (Keynes, General TheoryGeneral Theory, 1937), 1937)
Friday, April 21, 2023Friday, April 21, 2023 4545
But We Need But We Need Foreign Coordination Foreign Coordination for US Expansion to be Successfulfor US Expansion to be Successful
Benefits of lone expansion “leak Benefits of lone expansion “leak out,” other countries free ride.out,” other countries free ride.
Alternatives to joint expansion are Alternatives to joint expansion are protectionism and competitive protectionism and competitive devaluations.devaluations.
US long-term “Fiscal Gap” makes US long-term “Fiscal Gap” makes lone expansion untenable. lone expansion untenable.
Friday, April 21, 2023Friday, April 21, 2023 4646
Friday, April 21, 2023Friday, April 21, 2023 4747
Long Term Fiscal Gap: Long Term Fiscal Gap: UnsustainableUnsustainable
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
Friday, April 21, 2023Friday, April 21, 2023 4848
Sure asSure as DebtDebt and Taxes and Taxes
http://www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO_Testimony.pdf
Friday, April 21, 2023Friday, April 21, 2023 4949
Inflation/Devaluation Inflation/Devaluation a Powerful Temptation for a Powerful Temptation for
Highly Indebted GovernmentsHighly Indebted Governments
• Germany after WWI• Russia after the Revolution• Soviet Union after the Cold War• Many Developing Countries after spending, investment binges
(See L. Kotlikoff & S. Burns, The Coming Generational Storm, 2004)
Friday, April 21, 2023Friday, April 21, 2023 5050
Implications of Limited Pass-ThroughImplications of Limited Pass-Through
Linda Goldberg (FRBNY) has shown that Linda Goldberg (FRBNY) has shown that
Dollar DevaluationDollar Devaluation means: means:• Improved Earnings on Foreign AssetsImproved Earnings on Foreign Assets• Easier Debt ServicingEasier Debt Servicing• Smaller Trade DeficitSmaller Trade Deficit
And at the same time,And at the same time,
• Minimal Costs in further InflationMinimal Costs in further Inflation
So - What’s Not to Like?So - What’s Not to Like?• FRBNY Governor Frederic Mishkin says FRBNY Governor Frederic Mishkin says
“Devaluation cannot be a policy.” (I think he “Devaluation cannot be a policy.” (I think he means an means an explicitexplicit policy.) policy.)
Friday, April 21, 2023Friday, April 21, 2023 5151
Inflation/Devaluation Appears to be Inflation/Devaluation Appears to be a “Painless” Way Out of Debta “Painless” Way Out of Debt
Friday, April 21, 2023Friday, April 21, 2023 5252
Promising Investments?Promising Investments?Short-Term Shorts Short-Term Shorts (Aggressive):(Aggressive): ShortsShorts on the Dow, S&P (DOG, SH, SDS: on the Dow, S&P (DOG, SH, SDS:
en.wikipedia.org/wiki/Inverse_etfen.wikipedia.org/wiki/Inverse_etf))
Medium-Term Holds Medium-Term Holds (Cautious):(Cautious): USUS Treasuries Treasuries (but not long term – remember inflation)(but not long term – remember inflation) GoldGold, , SilverSilver, other precious metals, other precious metals
Long-Term Holds Long-Term Holds (Patient):(Patient): Non-Dollar Assets in Non-Dollar Assets in Emerging MarketsEmerging Markets Renewable Energy Renewable Energy TechnologyTechnology PharmaceuticalsPharmaceuticals: tied to global incomes, high dividends: tied to global incomes, high dividends
Summary of ConclusionsSummary of Conclusions RecessionRecession will be will be long and deeplong and deep: housing : housing
slump, interbank lending, financial markets slump, interbank lending, financial markets likely to “overshoot” on low side.likely to “overshoot” on low side.
CTCT is “ is “middle of the packmiddle of the pack” for housing prices ” for housing prices and employment stability.and employment stability.
Greatly expanded federal spending Greatly expanded federal spending is is needed in the needed in the short-termshort-term..
Long-termLong-term, however, US government , however, US government debt is debt is unsustainableunsustainable..
There are still There are still some places some places to put your to put your money!money!
Friday, April 21, 2023Friday, April 21, 2023 5353
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