TheMoneyIllusion

  A slightly off-center perspective on monetary problems.

12 Responses to “The banking crisis that didn’t happen”

1. david
   8. August 2012 at 19:29
   

   Didn’t the Hong Kong Monetary Authority sense a bubble coming and oblige banks to a lower LTV ratio?

   The bankruptcy rule bit might require more elaboration. The extent to which the bank retains its solvency is exactly the extent to which households become insolvent, yes…?

2. Dan S
   8. August 2012 at 19:52
   

   “Australia; an island of sanity in a world gone mad.”

   Makes me think of the movie “On the Beach,” where Australia is the only habitable place left in the world after a nuclear war.

3. Greg C
   8. August 2012 at 21:15
   

   Hyun Song Shin is not “of the RBA.” He’s an Economics Prof at Princeton. He does research in awesomeness! Check out his work at hyunsongshin.org. Australia may indeed be a island of sanity in a world gone mad (I have some doubts), but the US is still quite good at hiring the best talent that the world offers.

4. Ari Tai
   8. August 2012 at 21:19
   

   Australian banking has other challenges (large equipment loans to growing agribusiness struggling with bad weather losses), but “jingle mail” is not one of them (U.S. and Britain believe the bank assumes all loan risk irrespective of loan contract – unlike Australia – and Canada). If you speculate with a bank’s money and can’t repay, the judges treat you harshly. Your ordered to sell off all excess – including extra cars, furniture, take your children out of their private schools, forgo private health insurance, etc. The typical mortgage portfolio has a few notes in trouble – but those are true tragedies where the asset was a starter home with better than average LTV so the bank can extend generous terms and be seen as a good citizen – rather than a vulture.

5. Saturos
   8. August 2012 at 21:22
   

   Monetary policy works by manipulating asset prices, especially long-term interest
   rates. Although a central bank generally directly controls only the overnight interest
   rate, its communication policy serves to guide the market’s expectations into doing
   its bidding. By moulding market expectations, the central bank can manipulate
   long-term interest rates, and thereby affect mortgage rates, corporate lending rates
   and other prices that have a direct impact on the economy.

   That sounds good, escpecially if you take “prices” broadly enough, and also the suggested transmission mechanism (Modigliani as well as Tobin/interest rate effects). But then he says:

   The wider consequences
   of monetary policy for the fi nancial system as a whole receive less weight in
   central bank pronouncements on monetary policy.

   and

   When balance sheet
   changes affect asset prices, and asset-price changes affect balance sheets, the loop thus created can generate amplifi ed responses to an easing of monetary policy
   that cannot easily be unwound without exacting large economic costs.

   A sentence like: “a Tinbergen-style allocation of instruments to goals
   is envisaged where the goal of monetary policy is to ensure price stability, and
   supervisory/prudential policy is aimed at fi nancial stability.”

   sounds good on its own, but not in the context of: “the consequences of the central bank’s actions are seen almost exclusively through the lens of the IS curve – that is, through quantities such as consumption and investment. The wider consequences of monetary policy for the financial system as a whole receive less weight” which to me sounds frighteningly creditist and Bernankean. He talks about the bank-lending and bank-capital channel. He then essentially argues against those who suggest that all that is needed is to find the correct quantity of money regardless of transmission by saying,

   The amplified response to the easing of monetary policy, by itself, need not be a problem for policy-makers if they can fine-tune their monetary policy levers to take
   account of the amplification. Rather, the problem is the highly asymmetric nature of the mechanisms at play ‘on the way up’ versus the mechanisms ‘on the way down’.
   If the bursting of a property bubble impairs the solvency of the financial sector, then the dynamics ‘on the way down’ can turn into an extremely messy affair, involving
   a whole new set of mechanisms that did not figure in the initial inflating of the bubble. Default, financial distress, and inefficient liquidations will all conspire to
   exact very large economic costs.

   The bit that you quote is good. But you’ve been sneaky, you took it right out of context! He goes on to say:

   More systematic empirical evidence is not so encouraging for a country that undergoes a property-price boom financed by large increases in private credit.
   Borio and Lowe (2002a, 2002b, 2004) exhibit evidence that the joint occurrence of property booms and ‘excessive’ private-sector credit growth help predict banking
   distress, economic weakness and disinflation over a three- to five-year horizon.

   Combined with the last two sentences in the quote you picked, it’s unclear why you think the paper shows that Australia is an “island of sanity”. He’s clearly suggesting that things may not turn out so well for Australia – he thinks that we are building up “financial imbalances” which will put us into a downturn. He is subscribing to “what goes up must come down” thinking.

   It is one of the tenets of good banking practice that the
   banker should look at the borrower’s future cash flows, rather than be fixated by
   the value of the borrower’s collateral assets.

   He may not realize it, but that is the answer to his worries. When he talks about policy inflating bubbles, he is of course contradicting the “Tinbergen-style” recommendation. If he followed it, allowing monetary policy proper to focus only on flows of actual spending (NGDP), then he wouldn’t have to worry about asymmetries between making policy more expansionary or more contractionary, provided he was level-targeting the forecast. Expected NGDP can always be gotten to where you need it to be, and then the state of the financial sector is no obstacle to policy meeting its macro-stability objectives.

   Basically I think you’ve spoken prematurely in addressing the RBA as an ally. Consider the final three paragraphs:

   Taken together, the increased reliance on short-term incentives and the greater immediacy given by marking to market hold huge significance for the conduct
   of monetary policy. I opened this paper by noting that monetary policy works by manipulating asset prices, especially long-term interest rates. The orthodox view of
   monetary policy is that, although the central bank generally directly controls only the overnight interest rate, it can nevertheless manipulate long-term interest rates
   since long-term rates are determined by expectations of the future course of short-term rates (modified by the appropriate risk premium). By charting a path for future
   short rates, and communicating this path clearly to the market, the central bank can control long-term rates. Having thus gained control of long-term rates, monetary
   policy works through the IS curve – through quantities such as consumption and investment.

   This view of monetary policy reflects the origins of today’s macroeconomics in the IS-LM view of the world, except for the fact that the ‘LM’ part has now been
   discarded. We have ended up with an exclusively ‘IS’ view of the world. In this world, financial markets play only a passive role, populated with far-sighted but
   essentially passive agents. It is a moot point whether such a view of financial markets was ever valid, but it is becoming evident that it is less of a good approximation
   today. Fed Chairman Alan Greenspan’s ‘conundrum’ as to why long rates are so low today is a symptom of the breakdown of this view of markets.

   When fixed-income traders and hedge funds trade 10-year swaps, are they influenced primarily by their forecasts of the future path of the fed funds rate over the next 10 years? Perhaps. What is clear is that there will be other shorter-term considerations that enter into their calculations. Understanding these considerations
   and heading them off will become an increasingly important part of monetary policy. The distinction between monetary policy and policies towards financial stability
   are perhaps less clear-cut than is supposed.

   If I understand you correctly, Scott, you should fundamentally disagree with this view. (Enough to do a post?)

6. Greg Ransom
   8. August 2012 at 23:44
   

   The ‘Austrian’ label is dominated by a party line which is fundamentally anti-Hayekian as far as the picture of how to do economic science goes, ie as far as the empirical problem & contingent causal explanatory mechanism of economic goes. The ‘Austrian’ label is also tainted by a predominant party line on macroeconomic explanation which differs in substantive ways from core elements of Hayekian macroeconomics, eg on the endogenous nature of monetary disequilibrium in a money economy without central banking, and on the role of shadow money booms and crashes in the boom & bust & secondary deflation/depression cycles of the economy, and on the nature and definition of capital goods, etc.

   So, like George Selgin, I eschew the ‘Austrian’ label — you are welcome to it Scott.

   I prefer the ‘Hayekian’ label for the scientific research program advanced by Friedrich Hayek, both as a means of product differentiation and as a necessity in order to sidestep inevitable confusion and misunderstanding.

   But this listing of top ‘Austrian’ sites did give me an out-loud laugh. 😉

7. Jim Glass
   8. August 2012 at 23:59
   

   Most economic historians use the WPI, which rose by 22% in 12 months

   After falling 10% the prior 12 months — a sudden increase in the WPI of 32 percentage points!

   Some pointed to the CPI, which only increased by a bit over 5%

   That’s 5.6% to be exact. After falling 10% the prior 12 months — a sudden increase in the inflation rate of 15.6%!

   If the CPI increased from the current level to 5.6% next year, would people be saying “only” 5.6%?

   If the CPI next year is 15.6% higher than this year, will people be saying it increased by “only 15.6%”?

8. Wadolowski
   9. August 2012 at 00:35
   

   Prof. you’ve written:
   “Australia; an island of sanity in a world gone mad.”

   What if prof. Keen’s analysis is correct, and you’re making mistake by totally ignoring the level of private debt and there will be bubble burst in Australia:

   http://www.debtdeflation.com/blogs/2012/08/02/australian-house-prices-update-june-2012/

   Would you change your mind, if the facts change?

9. RebelEconomist
   9. August 2012 at 01:24
   

   Yes, it is not inevitable that a banking crisis follows the bursting of an asset price bubble, if the banks’ domestic lending is a small part of their total business – the banknote issuing banks in Hong Kong are HSBC, Standard Chartered and Bank of China, for example. And it helps if the country concerned has net foreign exchange reserves of about 40% of GDP that it can use to buy 7% of its domestic stock market in a few days to stem a market crash, and it owns practically all of the land in the country so that it can underpin the property market by cutting off land supply.

   The example of Hong Kong in the Asia crisis is hardly relevant to the effect of the present financial crisis on the major global economies.

10. Il Gattopardo
    9. August 2012 at 05:02
    

    RebelEconomist,

    You are right. Actually, HK experience is totally irrelevant to whatever Shin and Sumner have to say about monetary policy anywhere else. Don’t be surprised, however. We have seen too much BS about monetary theory and policy in the past four years because many economists have been trying to re-introduce money and finance into macroeconomics and at the same time to be seen as policy experts to help politicians to deal with the crisis. You can see how grotesque the situation is because they have to rely heavily on the authority of dead economists to make their points –points that were of little value when these economists were alive and are totally irrelevant today because of the many changes in how advanced economies work. They spend too much time searching for arguments in old books and papers when they should be trying to understand how these economies work.

11. Sean Brown
    9. August 2012 at 05:42
    

    1. Bankruptcy laws in Spain – like most other countries, triggered upon mortgage default unlike some U.S. states – are very rigorous. Wage garnishment is a high % of income and ends only when you’ve paid off the principle. Despite this, I have heard extremely well-qualified people say the real rate of resi mortgage default there is 20%+. (If anyone wants, we can argue about why the reported 3% is wrong.) Part of this certainly has to do with higher LTVs – anywhere from 70% to 90%+, depending on who you believe – and the current 25% unemployment rate.

    2. Australia has a somewhat less punitive bankruptcy regime than Hong Kong, as well as significantly higher LTVs. (However, it is a more rigorous regime than the U.S. or Canada.) There is wage garnishing for 3 years, vs. 4 in HK, but no wages are garnished below $62k/year for a head of household and you keep your retirement-account assets. In HK, all assets are disgorged and for 4 years you must “make contribution towards your estate in bankruptcy out of your personal income as assessed by the Provisional Trustee /Trustee;” I am not sure what standard this equates to in real life.

12. TheMoneyIllusion » What goes up must come down, but it need not come “back down”
    9. August 2012 at 15:01
    

    […] commenter named Wadolowski recently asked: What if prof. Keen’s analysis is correct, and you’re making mistake by totally […]

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