Archive for September, 2007

Assorted Links

September 18, 2007

1. MR points to some facts about rich people:

In the first Forbes 400 [1982], oil was the source of 22.8 percent of the fortunes, manufacturing 15.3 percent, finance 9 percent, and technology 3 percent.  By 2006 oil had fallen to 8.5 percent and manufacturing to 8.5 percent.  Technology, however, had risen to 11.75 percent and finance to an extraordinary 24.5 percent.

The average net worth in 2006 of Forbes 400 members without a college degree was $5.96 billion; those with a degree averaged $3.14 billion.  Four of the five richest Americans — Bill Gates, casino owner Sheldon Adelson, Oracle’s Larry Ellison, and Microsoft cofounder Paul Allen…– are college dropouts.

2. MR also points to Google’s interview questions. For instance, imagine you apply for software development and the question you are asked is this: 

How many piano tuners are there in the entire world?

3. WSJ Blog points to Bernanke’s views on Great Depression.

4. Rodrik asks one economics or two?

5. Mankiw points to an excerpt from the much talked about book by Alan Greenspan. MR points to some comments on the book.

6. Rajeev Malik says Cowboy approachshould be avoided in India. I agree.

7. BS has a nice interview of V. Thulasidas, the chairman of the merged Air India and Indian Airlines. He says:

Given the vastly higher salaries, and levels of freedom to mould organisations, I ask if Thulasidas would opt for an MBA, were he to be venturing out into the world all over again.

“No,” he says, without even blinking. For two reasons, he says. First, no other service, apart from the IAS, offers the same opportunity to work with different people in completely different work environment.

The second reason, I think, is quite ironic — Thulasidas says the limitations under which a public sector manager has to function make the job a lot more challenging.

Pension Funds allowed more exposure to equity

September 17, 2007

Finance Ministry has revised the investment pattern of non-govt. pension funds.

The break up (asset allocation) is as follows:

                                                                    Earlier     Revised
1. G-Secs or G-Sec based MFs               25                  35
2. State Govt. Bonds                                 15                   -
3. PSU/PSB Bonds                                    25                 25
4. Any sub-category in 3                         30                  30
5. Equity                                                     5                    10

Total                                                          100                100

Explanations:

  • G-Secs are govt bonds. Earlier 1 & 2 were seperate and now they have been clubbed as one. So, a PF can invest all 35% in State govt secs or can adopt a mix. However, in MFs maximum investment is 5% i.e. remaining 30% have to be bought from market. This is a welcome move as it gives the fund manager more leeway to invest.
  • Atleast 25% of (1) is to kept in an active portfolio
  • The 3rd category has been expanded.
    a) Now, PFs can invest in time deposits of private banks as well. As Public Sector Banks’ time deposits were allowed, Pvt Banks time deposits are also allowed.

    The Pvt banks allowed – banks must meet conditions of continuous profitability for three years; maintaining a minimum CRAR of 9%; having net non-performing assets of not more than 5% of the net advances and having a minimum net worth of not less than Rs.200 crores.

      b) Money Market MFs
     
c) Rupee Bonds issued by ADB, World Bank etc.

  • So now, there are 5 asset categories in (3)-
    i) PSU Bonds/PSB Bonds
    ii) Public Banks/ Pvt Banks deposits
    iii) CBLO
    iv) MMMF
    v) Rupee Bonds issued by ADB etc.
  • In 4, the trust can invest 30% in any of the 5 categories in (3)
  • Equity- Shares of companies that have an investment grade debt rating from at least one credit rating agency/ Shares of companies figuring in BSE Sensex and /or NSE NIFTY 50 and / or in equity linked schemes of mutual funds regulated by SEBI.

I think it is a welcome move. Allowing more investments in equity market is welcome as pension fund money can help Indian markets become less dependent on Foreign Institutional investor.And then allowing PFs to invest in Rupee Bonds issued by ADB etc would provide more liquidity in this market and build confidence in this market.

However, I think something could have been done to address the corporate bond market. As of now, guidelines only allow to invest in bonds of public sector bodies and public sector banks. This could have been expanded to bonds of private sector as well.

Assorted Links

September 17, 2007

1. MR points to a new paper from Steve Levitt.

2. WSJ Blog points China is exporting inflation.

China’s shift from source of deflation to source of inflation appears to reflect a strengthening Chinese currency, upward pressures on wages and other costs there, and rising prices of energy and commodities used to make many Chinese goods.

3. Fin Prof points out hedge funds lure Professors.

4. Hamilton warns that a tsunami is round the corner.

5. Jaideep Misra points to an interesting paper on vehicle ownership.

6. ET has an edit on equity Exchange for SMEs. Meanwhile BSE is planning to revamp its SME platform.

7. AV Rajwade praises China.

8. Vinayak Chatterjee on soft underbelly of infrastructure.

A good summary on Asian Financial Crisis

September 14, 2007

Janet Yellen, President, San Frasisco Fed, has given an excellent speech on whys and hows of Asian Financial Crisis. It was given on Feb 6, 07.

 She says there has been huge literasture since the crisis and it can be broadly divided into 2 types:

According to one view, this situation is best characterized as a “liquidity” crisis—much like a banking panic, where depositors’ fears about insolvency, well-grounded or not, become a self-fulfilling prophecy as their withdrawals en masse bring the bank to ruin.

The second view focuses more on the vulnerabilities that existed in these nations’ economic fundamentals, which threatened to lead to solvency difficulties.

Post crisis

Between 1999 and 2005, these nations enjoyed average per capita income growth of 8.2 percent and investment growth averaging nearly 9 percent, with foreign direct investment booming at an average annual rate of 17.5 percent. Moreover, all of the loans associated with the International Monetary Fund’s assistance programs during the crisis have been paid back and the terms of those programs have been fulfilled.

What have been the policy changes: 

One such policy change has been an increasing shift away from targeting exchange rates and toward targeting an explicit desired inflation rate. Korea moved in this direction in 1998, followed by Thailand in 2000 and Indonesia in 2005.

Korea, Malaysia, Thailand, and Indonesia have also moved to improve banking supervision and regulation and to introduce more market discipline since the crisis. Korea’s progress in strengthening its supervision of financial institutions is especially significant.

Another step towards decreasing the extent of bank-centered finance and the scope of implicit government guarantees on investment has been the development of local currency bond markets.

However, these countries still control exchange rates despite inflation targeting.

Now, it should be admitted that these countries still manage their exchange rates to some extent. In fact, recent moves by the Thai government indicate an increased emphasis on this issue.

I pointed this issue earlier as well.

She then discusses the lessons learnt from the crisis – strong fin system is important, every country is different (a point made by Krozner in his recent speech), transparency in accounting and macro policies.

She discusses the role of China and how it can play a role in stabilising the region as well.

A nice summary. Give it a quick read.

Assorted Links

September 14, 2007

1. I have just started reading Taleb. But this paper pointed out by Fin Prof is surely going to involve some fireworks.

2. MR points to a profile of a rising India born economist- Raj Chetty.

3. How many Americans know Bernanke? WSJ Blog points to the poll results. WSJ Blog has another story of Greenspan on subprime mess.

4. WSJ Blog has superb stuff in its assorted section. Read all. Bernanke might make a debut on youtube putting his comments on Se 18 on the video sharing website.

5. Mankiw asks did Fed announce a secret rate cut in August.

6. Rodrik on multilateralism and cites 2 papers that  summarise his work. The papers should be a good read as his work on development is a lot of food for thought.

7. TT Rammohan has some nice posts- one on India sparkilng (I have my doubts on that, India is growing but lots of issues need to be addressed, you really cannot attribute an oversubscription in a power company to India sparkling.), two on financial inclusion and three on India’s banking system.

8. JR Varma points to a super paper by Bank of England on current market turmoil. Well, here is Mervyn King and his team at their best. Willem Buiter’s comments on the paper are a must read. He says:

Following the bail out of Northern Rock, I can only conclude that the Bank of England is a paper tiger. It talks the ‘no bail out’ talk, but it does not walk the talk.

9. There are some nice articles on education/talent:

Manoj Pant says the problem in Indian education is not colleges but teachers.

Deepak Wadhawan says BPO is loosing talent. There is related article in American on the same in US where most people prefer economics courses to computer science.

10. TCA in his weekly column, points to a newBIS paper.

Bernanke revisits Global Imbalances

September 13, 2007

The issue on global imbalances has been there for quite some time but the debate on the same was started by the speech given by Bernanke in April 2005 . The speech became a rage for its global saving glut hypothesis. Number of papers then followed on the subject highlighting the various factors responsible for global imbalances. I have several posts on the same here.

Bernanke  revisited the subject recently (Sep 11, 2007) and gave yet another super speech. He first summarises his previous thoughts, then updates the developments and finally presents fresh insights on the subject.

Here are a few facts:

The U.S. current account deficit has widened further in the past two years, from $640 billion in 2004 (5.5 percent of GDP) to $812 billion in 2006 (6.2 percent of GDP). In an accounting sense, the increase in the U.S. deficit over this period reflects primarily an increase in the investment rate from about 19 percent of GDP in 2004 to 20 percent of GDP in 2006

Meanwhile, the aggregate current account surplus of emerging-market economies expanded about $350 billion, from $297 billion in 2004 to $643 billion in 2006; almost all the increase was attributable to a higher aggregate rate of saving.  A significant portion of this further growth is due to China, whose current account surplus swelled an additional $180 billion, rising from 3.6 percent of national output in 2004 to 9.4 percent in 2006. 

The combined current account balance of the countries of the Middle East and the former Soviet Union (which include a number of large oil exporters) rose about $150 billion between 2004 and 2006.  Again, the increase is almost entirely reflected in higher saving rates, as the oil exporters continue to save a large portion of the increased revenue resulting from higher oil prices. 

How about interest rates? 

Since I discussed these issues in March 2005, real interest rates have reversed some of their previous declines.  For example, in the United States, real yields on inflation-indexed government debt averaged 2.3 percent in 2006 as compared with 1.85 percent in 2004.  In the past few weeks, that yield has averaged about 2.4 percent.  Inflation-adjusted yields in other industrial countries have also started to move back up after falling in 2005

But ideally with huge capital flows, the interest rates should have gone down. He explains:

Further increases in net capital flows from the developing economies, all else being equal, should have further depressed real interest rates around the world.  But as I have noted, in the past few years, real interest rates have moved up a bit.  This increase does not imply that the global saving glut has dissipated.  However, it does suggest that, at the margin, desired investment net of desired saving must have risen in the industrial countries enough to offset any increase in desired saving by emerging-market countries. ….

He then gives both the +ves and -ves of this global imbalances and the way it can be reduced.

Highly recommended.

Assorted Links

September 13, 2007

1. Ajay Shah points to a new conference in India on Capital Flows and their Consequences. It is being sponsored by National Institute for Public Finance and Policy and the Department of Economic Affairs, Ministry of Finance. It has a website and a blog (ahem) as well.

2. WSJ Blog pointsout securities brokerage is the highest paid industry in India.

3. World Bank has a new report on China.

4. New Economist points to a new paper on Private Equity. It asks – Why do firms use private equity to opt out of public markets?

5. Mankiw on Fed Funds Rate cut.

6. Rodrik points out a new paper on slavery.

7. PSD Blog points to an interesting report on evaluation of World Bank lending.

8. Fin Prof has an interesting updateon Bear Stearns:

Joe Lewis bought a 7 per cent stake in Bear Stearns, the investment bank which has lost just over a third of its value after the closure of two of its hedge funds. Mr Lewis is best known in the UK for his stake in Tottenham Hotspur.

IIP Update Jul 07

September 12, 2007

The Index of Industrial Production (it is an indicator to gauge industrial activity in India) for the month of July 07 is out and it was quite a surprise. Some facts:

  • The  growth for July 07 (over July 06) was 7.1% much lower than 13.2% noted in June 06 (over July 05). Market expected about 9.6%.
  • Figure for both Apr 07 and June 07 was revised downwards by nearly 1% each. June 07 was revised lower from 9.8% to 9% and Apr 07 from 12.4% to 11.3%. This has also been a part of trend where revision is lower.
  • IIP is divided in 3 primary segments- mining, manufacturing (Mfg) and electricity. Mfg is about 80% of the index so focus lies there. It has grown by 7.2% half of 14.3% seen in Jul 06.
  • Within Mfg, the maximum fall has been in wood and wood products. It has been growing at 100+% growth since Feb-07 and in Jul 07 it grew by just 21%.
  • The most imp sectors in mfg (those having highest weight) are Food Products, Chemicals and Machinery. FP recorded negative growth at – 4.1%. Machinery grew by 7.7% but this is the lowest since Aug 05. From Aug 05, it has always recorded double digit (10-15) growth rates, and only in Apr 06 and Oct 06 it has been below 10% and in Oct 06 it was the lowest at about 4.5%.
  • With machinery going down it implies slowdowin in capital goods, which is indeed the case as capital goods sector grows at just 13% lowest since Nov-06. Only in Apr 07 was it lower at about 11%.

So, slowdown is kicking in. As it is July data, and that time the effect of rupee appreciation would also have led to the fall. Keeping watching this space for further developments.

Assorted Links

September 12, 2007

1. ECB President Trichet offers solutions to prevent next crisis.

2. New Economist pointsto this paper on Eco of securitization.

3. Mankiw pointsto Harvard’s economists views over Fed Meeting on Sep 18.

4. Rodrik shares his thoughts on the recent Chinese toys crisis.

Improving Supply Chain Management

September 11, 2007

I had written a post on Great Moderation sometime back. The idea is the variation in output has gone down substantially over the years. There are three reasons cited for this moderation:

1) Structural Reasons: changes in economic institutions, technology, business practices, or other structural features of the economy have improved the ability of the economy to absorb shocks.

2) Improved Macro policies: particularly mon policy

3) None of the above or simply plain good luck.

In the previous post, I highlighted two arguments, one the speech by Bernanke which advocated 2) and a neat paper by Peter Summers which does a cross country analysis to show Moderation is a phenomenon in most developed countries and 1) and 2) look better explanations than 3).

The paper pointed out to this wonderful work on Supply Chain Management (SCM) by Thomas Siems. He posits that better SCM could also be a possible reason for the Great Moderation. SCM would lend more weight to 1) as it is part of structural changes.

Siems discusses the meaning of SCM and how there were various eras of SCM from Mass Production (Ford era) to Mass Customization Era.

Its main point is shown via couple of neat charts. Chart 4 shows volatility of both production and sales has come down showing SCM has indeed helped in lowering volatility. He then shows in Chart 8 and Chart 9 which shows as SCM has progressed from Mass Production to Mass Customization, both output and productivity have got stronger. (The charts could have been better, infact a lot better as they are hardly visible)

Read the whole thing to get a different perspective. It is pretty simple as well.

Assorted Links

September 11, 2007

1. WSJ Blog points out Marty Feldstein resigns from Presidency of NBER . Here is his resignation letter. St. Louis Fed to look for successor to its President, William Poole.

2. Fin Prof points to a pretty humorous article:

“Should shareholders in a company care if the chief executive’s child dies? What if the mother-in-law passes away?…..slid by about one-fifth, on average, in the two years after the death of a CEO’s child, and by about 15 percent after the death of a spouse. As for an executive’s mother-in-law, the old jokes seem to hold: The researchers found that profitability, on average, rose slightly after her demise.

3. Ajay Shah points to an interesting book.

4. TTR points out that funds are being created to buy distressed funds and such purchases are quite attractive.

Indian Gas Sector: Some Basics

September 10, 2007

Most newspapers In India these days are full of reports about India’s gas sector. The newspapers focus mainly on how much the price of gas would be and the possible impact.

I never understood the sector and could not follow the developments at all. As Natural Gas is the fuel of the future, understanding it is critical as oil/gas is crucial for any economy.

However, I discovered this wonderful paper in EPW which explains the mechanics of the sector. It is written by a team that works for Prayas, an NGO based in Pune.

The paper starts by first using a bit of statistics to show the importance of gas in Indian economy:

Moreover, the quantum of gas finds from the first three rounds of NELP can supply about 77 billion cubic metres (bcm) of gas per year, which is equivalent to about 50 per cent of our oil consumption and about 72 per cent of our net import of crude and petroleum products in 2006-07.

Given the energy-hungry economic growth of the country, gas can form up to 22 per cent of the total energy basket by the year 2031-32 [KPMG 2007]. The Planning Commission (2006) estimates that all of India’s urea-based fertiliser would be gas-based in 2031-32. Therefore, it is an important fuel from the point of view of energy and food security of the nation.

India launched New Exploration and Licencing Policy (called NELP in newspapers) in 1997 which basically ushered competition in the sector by allowing private players. This would have solved two purposes- one, it would lead to exploration of vast regions in India and above all, help mitigate the energy needs of a growing country.

So, the paper first discusses pre-NELP regime Govt. controlled everything then exploration, production,and distribution all was done by govt. entities.

Then came NELP and this is where paper gets interesting. Under NELP blocks (of certain areas where gas could be found) were auctioned based on bidding process .

The bids were based on a “model production sharing contract” (MPSC)that stipulated the responsibilities of the contractor and the government respectively. The contractor would then bid for block(s) by presenting its credentials, submitting a work programme (that outlined the time frames and details of different phases of exploration and development) and declaring how it would share its profit with the government. These bids were then evaluated using different weightages for the different components such as technical ability, fiscal package and work programme, and the highest bidder won the contract for a block.

So far there have been six such auctions called NELP I, II and so on till NELP VI. The paper shows how government has evaluated bids in each different auction. The government offers 3 kinds of blocks: onshore, offshore and deepwater blocks and the paper also shows the bids in each.

The paper also tells that Gas is mostly found in deepwater blocks and hence the paper discusses only deepwater blocks later on. That is a nice bit of general knowledge.

The paper reveals that gas finds have so far been in NELP I,II & III and ONGC and Reliance Industries have formed a kind of duopoly:

Three players, RIL, ONGC and Cairn Energy, won the bids in these three rounds and, as shown in the first column of Figure 3, the duopoly of ONGC and RIL was prominent as they won 97 per cent acreage from these blocks, with RIL winning about 45 per cent and ONGC 52 per cent.

Who has been more effective?

If one compares the “effectiveness” of different contractors in finding gas, i e, the number of bcm of gas found per 1000 sq km of area explored, it turns out that Cairn Energy was the most effective, finding almost 6.7 bcm of gas per 1000 sq km, while RIL found 5.5 bcm per 1000 sq km. As against this, ONGC found just 1.1 bcm of gas per 1000 sq km. So, Cairn Energy was about six times as effective as ONGC and RIL was about five times as effective. This is so in spite of RIL and ONGC having roughly equal acreages in the fertile KG and Cauvery basins. It follows that either ONGC’s blocks are less rich than RIL’s or ONGC’s exploration approach is not as sound as RIL’s.

The paper then goes on to discuss the demand-supply conditions and projects the same in future. There are problems with demand projections so not much clarity on the same.

Then it focuses on the contentious issue – Gas pricing. It explains the basics of pricing and how the entire issue has come about and embroiled into a controversy.

Read the whole paper to get more details. The way it is written is pretty easy and absorbing. Great Stuff.

Reasons for high US Household debts

September 10, 2007

I have posted a number of posts on issues related to this subject. US has huge current account deficit and this poses huge problems for the entire global economy. For a summary of problems see this.

The source of high current account deficit is US households (HH) spending more than their incomes. In order to finance their expenditure they borrow leading to high indebtedness.  The natural question to ask is what has contributed to the rising debt? In other words, how have households managed to spend more than their incomes?

This recent Federal Reserve paper seeks answers to some of these very important questions. As it is co-authored by Donald Kohn, the Vice Chairman at Fed it automatically carries a lot of weight as well. The vice chairman at Fed also does active research; it shows how much research is respected in US.

This paper is one of the most popular papers being discussed because of the consequences involved. There are 2 ways to reduce current account deficit as Feldstein has put in his paper, one let dollar depreciate and two to increase US households savings. Now, if you need to increase US household savings you need to first understand what has led to this problem. 

How much is the indebtedness?

The ratio of total household debt to aggregate personal income in the United States has risen from an average of 0.6 in the 1980s to an average of 1.0 so far this decade!!

So for every $ of HH income there is a $ of debt.  

What explains this rise? Let us look at possible reasons and the evidence found for the same: 

1. Consuming more today and saving less for tomorrow: In other words have HH become more impatient? The paper says no, they have not become more impatient and are saving for retirement.

2.Have they become less risk averse? i.e. if you become less risk averse you might borrow.But the paper does not find any evidence of the same

3. Changing demographics: The logic is that you tend to spend more in your middle age and youth compared to old-age as your needs are more. As US baby-boomers (born between 1946 and 64 in US) have moved to mid-age, their debt-income ratos should move up. The paper suggests this has led to rising debt but not by as much.

4. Housing Prices and Financial Innovation: The paper says these two have contributed max to the rising debt.

The most important factors behind the rise in debt and the associated decline in saving out of current income have probably been the combination of increasing house prices and financial innovation. We noted a number of channels by which higher house prices can lead to higher debt. And causality probably runs to some extent in the other direction as well, especially in light of financial innovation that has reduced the cost and increased the availability of housing finance. Innovation has opened up greater opportunities for households to enter the housing market and for homeowners to liquefy their housing wealth, thereby helping them smooth consumption of all goods and services. One implication of this analysis is that a portion of the rise in debt relative to income probably reflects a shift in the level of spending that is not likely to be repeated unless house prices continue to increase as quickly as in the past and financial innovation continues to erode cost and availability constraints at a rapid pace.

So, housing prices alongwith financial innovation has led to the increasing HH debt. The consequences are even more interesting:

For one, household spending is probably more sensitive to unexpected asset-price movements than previously. A higher wealth to income ratio naturally amplifies the effects of a given percentage change in asset prices on spending.

Further, financial innovation has facilitated households’ ability to allow current consumption to be influenced by expected future asset values. When those expectations are revised, easier access to credit could well induce consumption to react more quickly and strongly than previously. In addition, to the extent that households were counting on borrowing against rising collateral value to allow them to smooth future spending, an unexpected leveling out or decline in that value could have a more marked effect on consumption by, in effect, raising the cost or reducing the availability of credit.

Another caution involves the distribution of credit and, in particular, a tendency for some households to become very highly indebted relative to income and wealth. The spending of those households is likely to be constrained by negative income or asset-price shocks as well as by households’ capacity to service their loans. Although these households represent a relatively small share of the population, in some circumstances such developments could have effects large enough to show through to the macroeconomy.

The paper tells us indirectly, why housing sector matters so much for the policymakers and why it poses a dilemma for them.

Rising housing prices along with financial innovation let HH to satisfy many of their demands which they otherwise would not have been able to meet (see last pages of  this speech to see how much they have risen in various countries) .

Now, firstly policymakers have little ideas to gauge whether price rise is as per market conditions or it is a bubble. So if they do something to correct the price rise the free-marketers say let markets correct themselves, and if they do not, the natural economic cycle takes over and in case of a slowdown, the housing prices crash, and this leads to insolvencies and foreclosures (as many purchases have been financed based on house price rise) and leads to difficult economic conditions (as we see in sub-prime markets today). To mitigate losses from second situation you need effective supervision which is generally ignored when times are good.

Coming back to the paper, it is a very simple one and pretty lucid and full of interesting facts. It is a must read to fill the missing block from the global imbalance jigsaw puzzle.

Highly recommended.

 

Assorted Links

September 10, 2007

1. Participate in the poll: What should Fed do in the meeting on Sep 18.

2. TT Rammohan has a good column in ET called the Big Picture. He has a blog as well. He points out to a nice article – Economists who left a lasting impact- and who didn’t.

3. Ajay Shah says:

A deep flaw of the intellectual landscape in India is that if you picked one topic, it isn’t easy to find six good quality authors to debate.

4. PSD Blog points to a new book that says development organisations like World Bank would be extinct like dinosaurs.

5. AV Rajwade shares more insights on financial markets:

Some instruments are so complex that it can take investment banks’ computers entire weekends to value them!

6. Subir Gokarn on education:

We can confine Mahesh Tutorials and its peers to training more and more people to compete for a fixed number of seats and let Helix Investments and its peers profit from that very juicy market scenario. Or, we can create an opportunity for both Mahesh and Helix to profit while expanding the capacity of the educational system to serve the interests of both students and employers. Our policy generates the former, but our compulsions clearly warrant the latter.

Banking Crises

September 7, 2007

I think you need to be a superman to keep up to the huge research literature being shared across. On top of that, you have number of conferences being hosted where number of ideas are shared and are important to read.

I am still struggling with comments given in Jackson Hole Symposium and we have another conference being hosted by San Francisco Fed. The topic is Asian Financial Crisis Revisited. (This is also one of the hot topics in conferences these days; as it has been 10 years since the crisis took place)However, the saving grace is that most papers are still not on the website. So atleast for sometime dont have to bother with new ideas on the subject.

However, Randall Krozner’s (Governor, Federal Reserve)  opening speech in the conference is available. And it is a wow.  A primer on banking sector and its impact on real economy.

He mainly discusses the findings of his recent paper ‘Banking Crises, Financial Dependence, and Growth’. I could not find the recent paperbut the earlier version is here.

As the conference is on Financial Crises, he discusses the same but focuses on banking sector – If Banking system collapses what happens? It makes sense as Banks are the major component in a financial system and more so in Asian countries.

What is Banking Crisis?

The definition of banking crisis I will use today, consistent with the definition in our recent paper, is an episode during which the capital of the banking sector has been depleted due to loan losses, resulting in a negative net worth of the banking sector.

What does the paper aim to find?

In particular, we investigate whether the impact of a banking crisis on sectors dependent on external sources of financing varies with the level of development of the financial system.  If the banking system is the key element allowing firms that depend heavily upon external funding sources to finance their growth, then an impairment of these intermediaries–in a system where such intermediaries are important–should have a disproportionate contractionary impact on precisely those sectors that flourished in “normal” times, due to their reliance on banks.  Thus, an important element of our analysis is the level of development of a country’s financial system, that is, whether it is “deep” (more developed) or “shallow” (less developed).

What are the findings:

More specifically, we find that in well-developed and deep financial systems, sectors highly dependent on external sources of funding tend to experience a greater contraction during a banking crisis than do externally dependent sectors in countries with shallower financial systems. In other words, sectors of the real economy that rely heavily on external finance (that is, do not fund capital expenditures through cash flow) tend to experience a substantially slower growth of value added during a banking crisis than those sectors that do not rely so heavily on external funding.  This effect is more pronounced in countries with more developed financial systems.  Our results hold for a wide group of countries and over a long time span, but as I note below, have particular relevance to emerging market countries. 

He then discusses the results in a bit more detail (and don’t worry no numbers are there) and suggests that good health of banking system is very important.

Read the entire thing. It is an excellent summary of many ideas.

Solutions for fixing subprime mess

September 7, 2007

I am trying to read through the speeches given in the just held Jackson Hole Symposium as reading papers take a lot of time. So far I have covered Bernanke and Feldstein. Both have interesting observations to make.

I just finished speeches by Stefan Ingves, Governor, Sveriges Riksbank and another by Ed Gramlich. Gramlich could not make it to the conference as e was ill. His comments were stated by David Wilcox, deputy director of research at the Fed. And then he passed away on Sep 5, 2007.

Ingves gives a perspective on the view on housing markets from a central bank that practices inflation targeting. As I have mentioned earlier, inflation targeters just look at inflation and ignore the rest. However, if asset prices are a threat to inflation, then they need to look at the problem.

He explains, Riksbank follows the same approach and is criticised both ways for their approach. Some say they put  much emphasis on asset prices some say they put little emphasis. But again like most he says there is not a very clearcut framework on how asset prices lead to building inflationary pressures in the economy and the need for central banker to focus on asset prices as well.

He believes it is better if we could reduce the probability of any negative event beforehand rather than fixing it after it happens.

The comments from Gramlich enlightened me further on the subject. When everyone is talking about solutions like cut in fed funds rate, effectiveness of discount rates, Bailouts from the government etc, we have some different ideas from Gramlich. It is a must read.

He says subprime has led to large number of people having their homes. America’s homeownership increased from 64% to 69% making US having one of the highest homeownership rates.  Subprime originations grew from 0 to $625 bliion a 26% annual increase.

Why the growth? Apart from Bernanke’s reasons Gramlich adds that decline of usury laws allowed lenders to make higher priced mortgages. This along with Bernanke’s reason of financial innovation and information technology led to the huge growth.

Now his ideas on the cource of problems. He had written a book on subprime earlier so he has more ideas than most:

1) He says there is more regulation for prime lenders than subprime lenders and it should be the other way round. Prime lending is done by commercial banks which are supervised where as most subprime by entities that are not federally supervised. Hence we have a problem.

2) This is a corollary of first.  We have more exotic products in subprime tha in prime. Prime has mostly fixed rate mortgages where as latter has all kinds of stuff. So we sell risky loans to least sophisticated borrowers. Nice idea this:-)

3) He says subprime markets losses could be minimised if some distressed properties could be bought and rented out.

His solutions for fixing the mess are changes in supervision and regulation and not lowering the fed funds rate. Between his ideas he suggests how changes can be made in current regulations to address this problem.

A nice, different perspective. However, changing regulations is not that easy. 

And then, he does not address the bigger problem. The subprime problem has two sides to it. One is the subprime loans itself which he addresses and two the financial innovation (securitization etc) which he does not really address.This is understood as he was an expert in matters pertaing to the former as this statement shows.

But, latter is a bigger problem as no one knows how big the problem is. The Banks etc have fuzzier balance sheets and it is difficult to understand how much exposure each one has. Hence, the problem remains unaddressed and only time will tell what will happen.

Keep posted for developments.

Assorted Links

September 7, 2007

1. Rodrik points to French view on Globalisation.

2. James Hamilton of Econbrowser on Fin Markets.

3. Jaspal Singh in ET has a nice article on Formula One.

4. ET reportsMinistry of Corporate Affairs has declared Sep 2007 as Month of Increased Investor Awareness. Why just one month? The website makes no mention of the same.

5. Madhukar Sabnavis has a nice article in BS on the way advertisements have evolved.

6. TCA points to a new paper in his Friday Column. This one is on Healthcare in India.

Feldstein on Housing Markets

September 6, 2007

Comments from Feldstein are always welcome as he puts his views in a very simple manner. I have covered a few of his papers and speeches here and here.

He always shares his views on the papers/views presented in the Annual Symosium held by Kansas City Fed.  His speech which was not there till yesterday has now been put online.

He says the housing sector problems can be summarised as 3 broad problems:

1) A sharp fall in prices could lead to fall in home building that could result in a recession
2) A subprime problem could lead to widening of credit spreads and freezing of credit markets
3) A decline in Home equity loans and mortgage refinancing could lead to greater decline in consumer spending

Read the speech for details on each point.  

What are his suggestions for the monetary policy?

His take is agreed Central bank’s mandate is to achieve price stability but it cannot let a slowdown in the economy to avoid bailing out the market participants that have taken risky positions.

And he says that there is more to financial markets (lack of trust, inability to value securities etc) than just liquidity and a problem in former along with slowdown in housing would lead to slowing economy.

Now when one gets a feeling that he advocates interest rate cut,  like a typical economist, he flashes his second hand. But then it is obvious as everything in eco has two sides to it. He says but Fed has to look at inflation as well as the falling $, higher food prices etc would fuel inflation. So it is about balancing growth and inflation together. And hence it is a tight rope walk for Fed. Tough times ahead for Bernanke and his team.

Update: Willem Buiter has some superb thoughts on Feldstein paper.  He points to ideas I had completely missed.

Feldstein has long stated that for US Households have to increase its savings in order to manage its huge current account deficit and correct the global imbalances. And in his speech he says becuase of this housing problem the consumoption could come down resulting in slowdown etc.

To this Buiter adds, how would savings increase if consumption does not come down? :-)

Assorted Links

September 6, 2007

1. The Beige Book (it summarises all the developments in eco from all 12 Fed regions) is out. WSJ provides a summary.

2. Willem Buiter has a nice post on the National Health System at UK.

3. Satyajit Das (a derivatives specialist) explains this crisis is unwinding of gigantic liquidity bubble.

4. Kanika Datta has a super article on Indian MBA system. We always overdo things in India especially with degrees. Everyone wants to do an MBA as no other occupation gives them a job. This makes too many MBAs in the country and we have something like a vicious circle.

Changing Financial System

September 5, 2007

I had mentioned about this conference sponsored by Reserve Bank of Australia here.

I just came across this paper from Claudio Borio, Research Head, BIS. It is a nice paper which summarises the changes and constancies in Financial Systems over the period. He anslyses how financial distress is caused and policy actions for the same.

It is things we as students of finance know about but his presentation of ideas is superb. His policy suggestions where he compares the policies to address financial system with that of policies to strengthen road safety is superb. Most academicians and policymakers have a fascination for making the same comparison and Borio does not disappoint.

A nice crisp paper without any arithmetic.


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