Lecture 5. Notes on the Current Crisis

Transcription

1 Lecture 5 Notes on the Current Crisis Mark Gertler NYU June 29

2 .4 Real GDP growth

3 18 16 core inflation federal funds rate

4 Figure 1: Selected Corporate Bond Spreads Basis points Quarterly NBER Q4. Peak Avg. Senior Unsecured Medium-Risk Long-Maturity Baa Note: The black line depicts the average credit spread for our sample of 5,269 senior unsecured corporate bonds; the red line depicts the average credit spread associated with very long maturity corporate bonds issued by firms with low to medium probability of default (see text for details); and the blue line depicts the standard Baa credit spread, measured relative to the 1-year Treasury yield. The shaded vertical bars denote NBER-dated recessions. 37

5 real GDP growth (right) lending standards (left)

6 Three Aspects of the Current Crisis 1. Disruption of Financial Intermediation 2. Unconventional Monetary and Fiscal Interventions in Credit Markets 3. Antiquated Regulation and the Need for Regulatory Reform 1

7 Disruption of Financial Intermediation From the late 198s, Remarkable Rise in Highly-leveraged Securitized Lending (i.e. the Shadow Banking System) 2

8 198Q1 1982Q1 1984Q1 1986Q1 1988Q1 199Q1 1992Q1 1994Q1 1996Q1 1998Q1 2Q1 22Q1 24Q1 26Q1 28Q Market Based and Bank Based Holding of Home Mortgages 7 Market-based Bank-based $ Trillion

9 Market Based Assets (27Q2) GSE Mortgage Pools 4.5 $ Trillion 8. Finance Co. 1.9 Commercial Banks Broker Dealers ABS Issuers 4.1 Savings Inst Market-Based Credit Unions.8 Bank-Based

10 Disruption of Financial Intermediation (con t) Factors underlying this increase: Basel capital standards Relaxation of credit standards Low interest rates Complacency about risk due to Great Moderation 3

11 Disruption of Financial Intermediation (con t) "You can t tell who is naked until you drain the swimming pool." (Warren Buffett) 4

12 Disruption of Financial Intermediation (con t) Sub-prime defaults in August 27 expose the weakness of the system Difficult to value many securitized assets: exposed to falling housing prices Term lending in money and interbank markets begins to dry up Global deleveraging process begins losses from asset firesales that fuel further losses Culiminates in Lehmann Brothers collapse 5

13 Securitized Lending Collapse Post Lehman

14 Assets by Money Fund Type: Jan 1 Sep 3, 28 Millions of $ Millions of $ 2,1, Prime (Left Axis) 7, 2,, 6, 1,9, 5, 1,8, Treasury & Agency (Right Axis) 9/12 9/18 4, 1,7, Treasury & Repo (Right Axis) 3, 1,6, 2, 1,5, Source: imoneynet Treasury Only (Right Axis) Jan 8 Feb 8 Mar 8 Apr 8 May 8 Jun 8 Jul 8 Aug 8 Sep 8 1,

15 Disruption of Financial Intermediation (con t) Transmission to Real Economy: Develeraging leads to increasing credit spreads. Distress spread broadly as commercial banks come under stress Banks have some direct exposure to sub-prime loans Banks absorb some of the decline off-balance sheet assets. 6

16 Before Investment Banks After Investment Banks CAPITAL ASSETS CAPITAL ASSETS Commercial Banks Commercial Banks CAPITAL ASSETS CAPITAL ASSETS

17 Target Fed Funds Rate M7 28M1 28M7 29M1 29M7 Index: 199m7= Index: 21m1= Index: 27m12= Conforming 3yr Fixed Rate Mortgage M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m12 Jumbo Mortgage Rate M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m12 Financial Conditions: Butterfly Charts (1 of 2) Real Fed Funds Rate Assumes 29M4 core PCE yoy% thru 29M6 27M7 28M1 28M7 29M1 29M7 Index: 199m7= Index: 21m1= Index: 27m12= Spread: 3yr Tsy & Conforming 3yr FRM.4 27M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m Spread: 3yr Tsy & Jumbo Mortgage Rate.4 27M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m recession: 199m7 (peak) to 1991m3 (trough) 21 recession: 21m3 (peak) to 21m11 (trough) Monthly charts using last daily data where available

18 8. Financial Conditions: Butterfly Charts (2 of 2) ML AAA corporate bond yield Spread: 1yr Tsy & ML AAA corp bond yield M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m ML BBB corporate bond yield M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m Spread: 1yr Tsy & ML BBB corp bond yield 1. 27M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m ML Junk bond yield M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m Spread: 1yr Tsy & ML Junk bond yield 2 27M1 27M7 28M1 28M7 29M1 29M7 199m1 to 1992m12 2m1 to 22m12 27m1 to 29m recession: 199m7 peak (blue vertical line) to 1991m3 trough (purple vertical line) 21 recession: 21m3 peak (purple vertical line) to 21m11 trough (red vertical line) Monthly charts using last daily data where available

19 Total CPI month change 3-month change (AR) United States: Prices Total PCE month change 3-month change (AR) Core CPI month change 3-month change (AR) Core PCE month change 3-month change (AR) Michigan Inflation Expecations (median) Next 5 to 1 years 1-year ahead Breakeven Inflation Barclays 5yr/5yr Macro Adv 5yr/5yr Macro Adv 1yr/1yr

20 Disruption of Financial Intermediation (con t) Implications for research: Existing literature (BGG, CMR, etc.) focuses on capital market constraints faced by non-financial firms and households Intemediaries are simply veils. 7

21 Disruption of Financial Intermediation (con t) On the one hand: Financial Accerelator mechanism extends naturally to financial institutuions. Motivates capital constraints on the ability to obtain funds Also provides way to think about how the wave of sub-prime defaults disrupted financial intermediation Especially given the high leverage of these firms. 8

22 Disruption of Financial Intermediation (con t) On the other hand: Need to do more than re-label non-financial firms as financial: Financial Firms exhibit a much higher degree of leverage and a much shorter maturity structure of debt. It is this feature that made the system so vulnerable to a housing pricing collapse. (Contrast with the equity price collapse of 2-21.) Understanding how such a high degree of leverage could emerge is an important policy question. Primitive Features of Financial Institutions vs. Moral Hazard from Government Protection 9

23 Disruption of Financial Intermediation (con t) Related Issue: Not only did the average amount of intermediary capital decline precipitously, the degree uncertainty over asset values skyrocketed. This increase in uncertainty had the effect of further tightening balance sheet constraints.. Not only a first moment effect on intermediation from the contraction in intermediary capital, there was as well second moment effect from the rise in uncertainty over the value of this capital. ("Toxic Assets") The paper by Christiano et. al. gets at this, but clearly much more work needs to be done. 1

24 Unconventional Monetary and Fiscal Interventions in Credit Markets. Unconventional vs. Conventional Monetary Policy Conventional: The central bank adjusts the short term rate to affect the market structure of interest rates. Unconventional: The central bank lends directly in private credit markets. Section 13.3 of the Federal Reserve Act: "In unusual and exigent circumstances.. the Federal Reserve may lend directly to private borrowers to the extent it judges the loans to be adequately secured." 11

25 Federal Reserve Assets Trillions of Dollars Repo Treasury Securities Other AMLF Maiden Lane I, II, III Other Credit (&AIG ext) PDCF, Other Broker-dealer TAF Primary Credit Currency Swaps Agency MBS Agency Debt TALF CPFF Trillions of Dollars.5.5 Aug-7 Oct-7 Dec-7 Feb-8 Apr-8 Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9 Federal Reserve Liabilities 2.5 Treasury, SFA Reserve Balances Treasury, ga Reverse Repo Other Currency Source: H41, Bloomberg Aug-7 Oct-7 Dec-7 Feb-8 Apr-8 Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9.5

26 Unconventional Monetary and Fiscal Interventions in Credit Markets. Fed s expansion of its balance sheet to directly channel credit to the private sector: Injection of equity capital into the banking the system by Treasury Along with expansion of various guarantees by the Treasury and the FDIC. Need to expand models so that we can offer advice on these kinds policies. 12

27 Unconventional Monetary and Fiscal Interventions in Credit Markets. Gertler and Karardi (29): These policies reflect a vary natural response to the disruption of financial intermediation that this crisis has featured. Unlike private intermediaries, the Fed is not balanced sheet constrained (or at least not yet.). As a lender of last resort, Fed should directly lend in markets where private intermediaries are constrained due to financial distress but credit risks are moderate. The evidence suggests that these kinds of policies have had some success in reducing credit spreads. 13

28 Liquidity Facilities CPFF and Commercial Paper Outstanding Billions of Dollars 1,9 1,8 1,7 Total (left axis) Source: Federal Reserve Board, Haver, FDIC Federal Reserve Net Holdings (right axis) Billions of Dollars Mar 31: ,6 Apr 17: FDIC TLGP 1,5 (right axis) Apr 17: 1, Mar-8 Jun-8 Sep-8 Dec-8 Mar month CP Rates over OIS Basis Points AA Financial Apr 17: A2/P2/F Non-Financial Apr 17: 61. Apr 17: 27. AA Asset-Backed ABCP CPFF Fee AA Non-Financial Unsecured CPFF Fee -1 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Source: Federal Reserve Board, Haver, Bloomberg Apr 17: 6. Basis Points TSLF Schedule 1 & 2 Total Outstanding Overnight Financing Spreads Billions of Dollars 15 Billions of Dollars 15 Basis Points 25 Basis Points 25 1 Schedule 2 Apr 15: Agency MBS Agency Debt Schedule 1 Apr 16: Apr 17: 8. Apr 17:. 1 5 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Source: Federal Reserve Board -5-5 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Note: Spreads are between overnight agency debt and Source: Bloomberg MBS and Treasury general collateral repo rates Agency MBS Transactions Agency MBS to Average 5y and 1y Yields Billions of Dollars 3 2 Outright Purchases Apr 15: Billions of Dollars 3 2 Basis Points 3 25 Fannie Mae Basis Points Temporary OMO Accepted Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Source: Federal Reserve Board, Haver Apr 17:. 1 2 Apr 17: Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Note: Spreads are agency 3 year on-the-run Source: FRB, Haver, Bloomberg coupon to average of 5 and 1 year yields 15

29 Unconventional Monetary and Fiscal Interventions in Credit Markets (con t). Additional Issues Asset Purchases vs. Equity Injections: Inflation Risks From Fed Balance Sheet Operations? Vastly overblown, in my view 14

30 Japanese money and prices Monetary base GDP deflator 1 8 Source: Bank of Japan, IMF

31 Inadequate Regulatory Structure and Regulatory Re-Design Emergence of the highly leveraged shadow banking system was facilitated by the existing regulatory structure. Now an across the board consensus for regulatory re-design. Research should contribute to this endeavor. Should build models where we can not only stress the banking system, but also stress test the overall macroeconomy. 15

32 Inadequate Regulatory Structure and Regulatory Re-Design (con t) Need to better understand the moral hazard consequences of different types of regulatory design. We have developed an impressive machinary to study credibility issues in policymaking but have mostly applied this machinary to the inflation bias problem. Time to shift to studying the consequences of different types of financial regulatory design. Now have an impressive literature on the optimal inflation target:. I look forward when we the we attack the problem of optimal financial regulatory designwiththesamedegreeofenergy.. 16