Reply to Tyler Cowen

Tyler Cowen asks:

Why are bank stocks falling so rapidly?

I can’t be sure, but my hunch is that bank stock prices are weakening for the same reason they crashed in the second half of 2008.  Falling NGDP expectations led to falling asset prices, which weakened the balance sheets of banks.

Many people assume low interest rates help banks.  Sometimes that’s true.  But not always.   Never reason from a price change . . .


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19 Responses to “Reply to Tyler Cowen”

  1. Gravatar of David Pearson David Pearson
    9. August 2011 at 07:37

    Bank stocks are weakening quickly because of fears over a bank run in Europe. As in 2008, rising systemic banking risk is causing NGDP expectations to fall. However, l.t. inflation expectations are remarkably stable given the steep drop in nominal Treasury yields and stock prices. This may be interpreted as markets saying, “we know the Fed will engage in more easing, but it is likely to produce more inflation than real growth.”

    We could debate significance of the gold price ad nauseum. The simplest interpretation is actors are hedging the tail risk of high and volatile inflaiton; tail risk that only emerges from the probability of excessive easing. BTW, there is no such thing as “safe haven” buying of gold: in every case but high inflation, actors are better off using currency as a safe haven. Investors buy gold as a haven from inflation, not from political or financial instability, except insofar as these lead to high inflation (which they often do!). Certainly, China industrial demand for gold appears to be an ever more remote explanation for the gold price rally.

  2. Gravatar of David Pearson David Pearson
    9. August 2011 at 07:40

    The phrase “…emerges from the probability of excessive easing”, above, is really incorrect. I meant to say that markets fear the long term financing of chronically high fiscal deficits by the monetary authority. This is the dominant source of inflation fears in countries with sustained periods of high and variable inflation.

  3. Gravatar of John Thacker John Thacker
    9. August 2011 at 10:39

    Hmm, my naive view today is that the markets were hoping for QE3, up as much as 2.5%, and then when all they got what a promise to “keep interest rates low where they are now,” they crashed.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. August 2011 at 10:57

    Eric Falkenstein has a novel idea; treasury bonds are now a Giffen Good:

    http://falkenblog.blogspot.com/2011/08/treasuries-new-kind-of-giffen-good.html

  5. Gravatar of John John
    9. August 2011 at 11:08

    Scott,

    If low interest rates are a sign of tight money, why not just have the Fed jack up the fed funds rate to say 5% and try to boost yields all along the curve? That way we’ll have no liquidity trap and no one will be able to compare us to Japan. Raising rates to 5% now wouldn’t be any more arbitrary than cutting them to 0.25%.

    I know you’re gonna say that it would be bad for the economy, but are the current low rates really so beneficial. There’s little empirical evidence that they actually are.

  6. Gravatar of Alex Godofsky Alex Godofsky
    9. August 2011 at 11:12

    John: it matters how the Fed goes about causing interest rates to rise. If the Fed tries to increase interest rates by further restricting the money supply, that would be bad. If they increase interest rates by increasing the money supply (and promising to keep doing so until NGDP returns to trend), that would be good.

    Oil prices can also illustrate this. Oil prices could rise because of further restrictions in supply (bad) or expected future increases in demand as we emerge from the recession (good).

  7. Gravatar of John John
    9. August 2011 at 11:14

    Here’s how you create a crappy economy for 10 or more years based on the US Japanese experience: bail out failed banks, cut interest rates to the bottom and leave them there, engage in fiscal stimulus, run the government debt up above 100% of GDP. What’s funny is that all these measures were recommended by economists at the time because the modern economics profession is a fraudulent bunch of snake oil salesman. If politicians in the US and Japan had done the opposite of what macroeconomists had said, they’d be in much better shape.

  8. Gravatar of W. Peden W. Peden
    9. August 2011 at 11:19

    John,

    Higher interest rates could be very good, if caused in the right way, just like hypothermic shivers going away is very good if caused by warming up after the hypothermia is addressed.

    I don’t think that low interest rates have hindered anything, but they aren’t enough in themselves and there are negative costs of them being so low, which is why we need QE and a recovery to get back to positive real interest rates.

    I agree about bank bailouts and fiscal stimulus. All fiscal stimulus does, when there is an independent central bank targeting inflation, is increase government spending as a % of GDP.

  9. Gravatar of Benjamin Cole Benjamin Cole
    9. August 2011 at 11:20

    Nada. The Fed will do nada. BTW, the CPI-U was at 219.964 in July 2008. It is at 225.722 for June 2011.

    Let’s get scared! The CPI up 2.62 percent in three years!! Run for the exits! Your currency is debased and next stop is Sodom and Gomorrah.

  10. Gravatar of David N David N
    9. August 2011 at 12:18

    Another reason might be that they’ve all started or will soon be suing each other over bad mortgages.

  11. Gravatar of Gabe Gabe
    9. August 2011 at 14:09

    Ben,
    I and many other Austrians are not so worried about the CPI-U moving from 219.9 to 225.7 over a three year period.

    The problem is that the only “solutions” to our zero-GDP- growth/high unemployment crisis being proposed by the mainstream economisthave been

    1. keynsian fiscal stimulus to the tune of $1 trillion/yr, which has succesfully pushed debt-GDP ratio to over 100%…and done nothing for the economy but save the big banks.

    2 TARP and QE1 monetary stimulus that saved the elite banksters while leaving the rest of the country in worse shape than ever and with zero confidence in our political/monetary elite.

    3 QE2 which propped up the stock market…moved oil to $110/barrel and shoved billions of more dollars into the pockets of the primary dealers…and then when the program ended the economy collapsed…revealing to all but the most ignorant that no real fundamental economic problems have been addressed over the last 3 years and in fact the economy is in worse real shape than ever.

    Yes I would like to see big QE3 announced this week…but solely for the benefit of my career and investments in commodities. QE3 will be great fun for those who can forsee it coming and time it well, but it will not benefit society at large.

  12. Gravatar of Morgan Warstler Morgan Warstler
    9. August 2011 at 14:16

    Because the banks are insolvent, they are not liked by the wing that controls Congress, and they will not have favored treatment after tax reform.

  13. Gravatar of Alex Godofsky Alex Godofsky
    9. August 2011 at 14:39

    Gabe: what effective economic recovery policy won’t cause oil prices to shoot up? In what state of the world does the economy recovers but oil prices don’t?

  14. Gravatar of Alex Godofsky Alex Godofsky
    9. August 2011 at 14:40

    Sorry for the broken italics there.

  15. Gravatar of Morgan Warstler Morgan Warstler
    9. August 2011 at 14:42

    Perhaps the Fed’s announcement today was an attempt at driving cash into stock and commodities without putting more into bank reserves?

  16. Gravatar of StatsGuy StatsGuy
    9. August 2011 at 16:58

    It seems many here need to read the news. There are several reasons bank stocks are dropping (house prices still fail to recover, and projections for recovery keep getting longer, for example). However, the most immediate reason has nothing to do with that. Rather it has to do with legal liability.

    Bank of America is dealing with a multibillion dollar likely settlement with states attorney general over fraudulent and illegal loan processing activity (like, directly lying about paperwork, and falsely signing documents to evict homeowners en masse). People discounted the lawsuits for a while, but over the past few weeks its become obvious the courts are going to treat them seriously.

    Second, AIG filed a 10 billion dollar lawsuit against Bank of America a few days ago.

    Seriously, NOT EVERYTHING IS ALL MONETARY POLICY.

  17. Gravatar of Rien Huizer Rien Huizer
    9. August 2011 at 18:45

    Gabe:

    “Yes I would like to see big QE3 announced this week…but solely for the benefit of my career and investments in commodities. QE3 will be great fun for those who can forsee it coming and time it well, but it will not benefit society at large.”

    Indeed! Scott, maybe the answer to your bank stock question is that the market does not expect QE3..

    Seriously, bank stocks are among the most practical for margin calls, so they may be selling a little faster than the rest.

    Also, of course the fundamentals for bank stocks are hardly better than they were a year ago. Low interest rates can have a negative effect on interest margins and make pricing of deposit product more difficult. Account management fees (in retail) should go up but that may be unpopular while some of the largest banks are still in a build-and-scap mode with their branch networks. So, the conventional wisdom is not correct. And, of course bank stock prices do not reflect the forthcoming period of 5% NDGP growth as far as the eye can see..Starting around 2016.

  18. Gravatar of Morgan Warstler Morgan Warstler
    10. August 2011 at 01:25

    Rien, I said the same thing.

    The Tea Party is in charge. The Fed needs to convince them. Funnily enough, the VERY WAY Ben would win support of TP, would also convince the economists that inform Fed thinking.

  19. Gravatar of Scott Sumner Scott Sumner
    10. August 2011 at 10:23

    David Pearson, If growth in recent months had been much higher, I very much doubt that banks would be in this situation.

    And inflation expectations are falling, although the SRAS is currently relatively flat, so real growth is falling faster. The same would be true if NGDP growth accelerated.

    I don’t think the markets see Fed easing, I think they see further Fed tightening.

    John Thacker, See my new post “Epic fail.”

    Patrick, I agree, but haven’t we always known that T-bond prices rise during periods of falling income? Perhaps he’s the first to call them Giffen goods.

    John, It all depends how they raise rates to 5%. If they do it with an easy money policy, I’m all for it. If they do it with a tight money policy, I’m opposed.

    Alex, We think alike.

    Ben, I agree.

    David, But why do they decline in value during periods where rates are falling?

    Gabe, You said;

    “The problem is that the only “solutions” to our zero-GDP- growth/high unemployment crisis being proposed by the mainstream economist have been”

    Then I guess Krugman, Rogoff, Mankiw, etc, are not mainstream economists.

    Statsguy, Yes, those factors matter, but it’s also obvious that changing NGDP expectations are affecting stock prices. What you describe is already in the market, and doesn’t explain the recent movements in bank stock prices.

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