Let me begin with the point on which I am in complete agreement with Treasury Secretary Henry Paulson and Federal Reserve Chair Ben Bernanke– it is hard to overstate just how scary this week’s developments in financial markets could be.
Category Archives: financial markets
The housing meltdown: Why did it happen in the US?
From a timely BIS working paper by Lucy Ellis released on Thursday:
Mortgage lending standards eased in many countries in recent years, but the limited available cross-country evidence does suggest that the process went further in the United States. Standards are difficult to measure because different aspects need not all move together (Gorton 2008), but the observed increase in early payment defaults in the United States (but not elsewhere) provides direct evidence that it occurred (Kiff and Mills 2007); Gerardi, Lehnert, Sherlund and Willen (2008) provide additional detail on the easing in lending standards.
Two developments seem to have spurred the easing in US standards. First, a range of legislative and policy changes had been made to encourage the development of a non-conforming (Alt-A and subprime) lending sector, lying outside the model defined by the government-sponsored enterprises (GSEs, Fannie Mae and Freddie Mac). Part of the motivation for this was a desire to ensure that home ownership was accessible to households who had historically been underserved by mortgage lenders (Gramlich 2007). In addition, the administration had wanted to reduce the GSEs’ domination of the mortgage market. Following problems with accounting and governance at both institutions, the GSEs’ capacity to expand lending was capped by new regulatory limits on their activities (Kiff and Mills 2007, Blundell-Wignall and Atkinson 2008). [emphasis added — mdc]
Some Observations on the Ongoing Crisis: Causes and Opportunity Cost Again
There’s a lot of commentary — more comprehensive and up to date than I can provide — on the crisis and the attempts to resolve the logjam in the financial markets.[0], [1] But I stilll have a couple of thoughts about the causes, and the implications, of the process that has resulted in so much turmoil this week.
Implications of Repricing of Dollar Denominated Assets
In the wake of global financial events, a couple of articles have caught my attention in terms of implications for the dollar. First was this Reuters account of a People’s Daily editorial, suggesting “diversification”. But it’s hard to discern the underlying message given the low signal to noise ratio in official publications. Today’s article in the IHT is a little more informative, not just about what’s going on in China but in Asia (where a lot of that “saving glut” was alleged to come from):
Palin, on the Ongoing Financial Crisis
In response to the largest de facto nationalization in US history, we have this example of Governor Palin’s comprehension of this issue (ABC News):
Saturday in Colorado Springs, Colo., Alaska Gov. Sarah Palin said, “The fact is that Fannie Mae and Freddie Mac have gotten too big and too expensive to the taxpayers. The McCain-Palin administration will make them smaller and smarter and more effective for homeowners who need help.”
Current Account Adjustment Redux? What’s Different this Time Around
Synergies of the unpleasant kind: recessions, credit crunches and housing busts
From the abstract of a new paper by Stijn Claessens, M. Ayhan Kose and Marco E. Terrones, entitled “What Happens During Recessions, Crunches and Busts?” (paper now online here):
We provide a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the 1960-2007 period. In particular, we analyze the implications of 122 recessions, 112 (28) credit contraction (crunch) episodes, 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts) and their various overlaps in these countries over the sample period. We document a rich set of stylized facts about the behavior of key macroeconomic and financial variables during these various events. Our results indicate that interactions between macroeconomic and financial variables can play major roles in determining the severity and duration of a recession. In particular, we show that recessions associated with credit crunches and house price busts are deeper and last longer than other recessions are. In light of our findings, we examine the implications of recent macroeconomic and financial developments in the United States for the future path of its economy.
Taylor rules, exchange rates, and the speculation about the dollar/euro rate
As Europe teeters on the edge of recession [0], and the United States remains mired in slow growth, expectations of what interest rates, and hence exchange rates, are shifting. Here’s a familiar depiction of where policy rates in the US and the euro area have been, and where they are predicted to go.
Implications of adjustment to riskier dollar assets in a portfolio balance framework, illustrated in three steps
Consider a hypothetical world economy with assets denominated in dollars and euros.
Did Fannie and Freddie cause the mortgage crisis?
Some thoughts about the role played by the GSEs in the run-up in mortgage debt and house prices.