Shadow banking and the economy
Alan Moreira, Alexi Savov 16 September 2014
The prevailing view of shadow banking is that it is all about regulatory arbitrage – evading capital requirements and exploiting ‘too big to fail’. This column focuses instead on the tradeoff between economic growth and financial stability. Shadow banking transforms risky, illiquid assets into securities that are – in good times, at least – treated like money. This alleviates the shortage of safe assets, thereby stimulating growth. However, this process builds up fragility, and can exacerbate the depth of the bust when the liquidity of shadow banking securities evaporates.
Shadow banking, what is it good for? At the epicentre of the global financial crisis, shadow banking has become the focus of intense regulatory scrutiny. All reform proposals implicitly take a stance on its economic value.
According to the prevailing regulatory arbitrage and neglected risks views, it doesn’t have any – shadow banking is about evading capital requirements, exploiting ‘too big to fail’, and marketing risky securities as safe to unwitting investors. The right response is to bring shadow banking into the regulatory and supervisory regime that covers insured banks.
Financial markets Global crisis Macroeconomic policy
shadow banking, banking, financial crisis, global crisis, regulatory arbitrage, liquidity transformation, financial stability, externalities, collateral, business cycle, financial regulation, financial fragility, liquidity, liquidity crunch
Quantifying the macroeconomic effects of large-scale asset purchases
Karl Walentin 11 September 2014
Central banks have resorted to various unconventional monetary policy tools since the onset of the Global Crisis. This column focuses on the macroeconomic effects of the Federal Reserve’s large-scale purchases of mortgage-backed securities – in particular, through reducing the ‘mortgage spread’ between interest rates on mortgages and government bonds at a given maturity. Although large-scale asset purchases are found to have substantial macroeconomic effects, they may not necessarily be the best policy tool at the zero lower bound.
Central banks have used various unconventional monetary policy tools since the onset of the financial crisis yet the debate continues regarding their efficiency. This column attempts to shed light on the ‘bang for the buck’, or the macroeconomic effects, of one such unconventional monetary policy – the Federal Reserve’s large-scale asset purchases of mortgage-backed securities employed during the Fed’s QE1 and QE3 programs.
Global crisis Monetary policy
monetary policy, unconventional monetary policy, large-scale asset purchases, central banking, financial crisis, Federal Reserve, quantitative easing, mortgage-backed securities, term premia, zero lower bound, interest rates, US, UK, Sweden, mortgages, global crisis
What were they thinking? The Federal Reserve in the run-up to the 2008 financial crisis
Stephen Golub, Ayse Kaya, Michael Reay 08 September 2014
Since the Global Crisis, critics have questioned why regulatory agencies failed to prevent it. This column argues that the US Federal Reserve was aware of potential problems brewing in the financial system, but was largely unconcerned by them. Both Greenspan and Bernanke subscribed to the view that identifying bubbles is very difficult, pre-emptive bursting may be harmful, and that central banks could limit the damage ex post. The scripted nature of FOMC meetings, the focus on the Greenbook, and a ‘silo’ mentality reduced the impact of dissenting views.
Financial crises are caused by imprudent borrowing and lending, but as former Federal Reserve chairman William McChesney Martin noted, it is ultimately up to regulators to ‘take away the punch bowl’ when the larger economy is at risk. Indeed, many have criticised regulators for failing to anticipate and prevent the 2008 crash (Buiter 2012, Gorton 2012, Johnson and Kwak 2010, Roubini and Mihm 2010). Little work has been done, however, on why regulatory agencies failed to act despite warnings from prominent commentators (Borio and White 2004, Buffett 2003, Rajan 2005).
Financial markets Global crisis Monetary policy
financial crisis, Federal Reserve, FOMC, global crisis, collateralised debt obligations, Credit Default Swaps, LTCM, CDOs, CDSs, central banking
Political booms, financial crises: Why popular governments are not always a good sign
Christoph Trebesch, Helios Herrera, Guillermo L. Ordoñez 06 September 2014
Financial crises are often credit booms gone bust. This column argues that ‘political booms’, defined as an increase in government popularity, are also a good predictor of financial crises. The phenomenon of ‘political booms gone bust’ is, however, only observable in emerging markets. In these countries, politicians have more to gain from riding the popularity benefits of unsustainable booms.
Financial crises: the search for early warning indicators
Financial crises are a recurrent phenomenon in the history of emerging markets and advanced economies alike. To understand the common causes of these crises and to prevent future ones from developing, economists have a long tradition of studying early warning indicators. Two well-documented predictors of financial crises are credit booms and capital flow bonanzas.
Financial markets Politics and economics
credit booms, financial crisis, politics, emerging markets, capital flows, public opinion, popularity
The impact of capital requirements on bank lending
Jonathan Bridges, David Gregory, Mette Nielsen, Silvia Pezzini, Amar Radia, Marco Spaltro 02 September 2014
Since the Global Crisis, support has grown for the use of time-varying capital requirements as a macroprudential policy tool. This column examines the effect of bank-specific, time-varying capital requirements in the UK between 1990 and 2011. In response to increased capital requirements, banks gradually increase their capital ratios to restore their original buffers above the regulatory minimum, reducing lending temporarily as they do so. The largest effects are on commercial real estate lending, followed by lending to other corporates and then secured lending to households.
The financial crisis has led to widespread support for greater use of time-varying capital requirements on banks as a macroprudential policy tool (see for example Yellen 2010 and Hanson et al. 2011). Policymakers aim to use these tools to enhance the resilience of the financial system, and, potentially, to curb the credit cycle. Under Basel III, national regulatory authorities will be tasked with setting countercyclical capital buffers over the economic cycle.
Macroprudential policy, capital requirements, regulation, bank regulation, BASEL III, Bank of England, financial crisis, bank lending, UK
Lessons from history for the European Financial Crisis
Selin Sayek, Fatma Taskin 05 July 2014
The European Monetary Union is unprecedented, but the Eurozone Crisis is not. This column draws upon the experiences of previous banking crises, and compares the Eurozone Crisis countries. Like Japan before the 1992 crisis, Spain and Ireland had property bubbles fuelled by domestic credit. The Greek crisis is very distinct from crises in other Eurozone countries, so a one-size-fits-all policy would be inappropriate. The duration and severity of past crises suggest the road ahead will continue to be very rough.
As of July 2014, we continue to debate whether the European economy is out of the woods. The effectiveness of policies and the prospects of full recovery are under scrutiny. The unique nature of Europe’s monetary union begets further questions of whether policies should be designed to resolve a single euro crisis, or whether they should be designed to resolve multiple European crises occurring simultaneously. A discussion of whether the sui generis European project has led to a sui generis set of financial crises would provide a framework for these policy discussions.
Economic history Europe's nations and regions Global crisis
eurozone, financial crisis, EZ crisis, GIIPS
The mainstream economics curriculum needs an overhaul
Diane Coyle 04 May 2014
The undergraduate economics curriculum is hugely influential, since today’s undergraduates are tomorrow’s policymakers. The massive policy failures before and after the Global Crisis have thus prompted a rethink. This column argues that there is a reasonable degree of consensus on the need for curriculum reform, but no agreement on whether this means rejecting the basic building blocks of the subject. Nevertheless, undergraduate courses in five or ten years will almost surely have changed considerably in character.
One of the delayed consequences of the financial crisis is a widespread and apparently growing desire to change how economics is taught. Students in a number of countries, including vocal groups in Chile and the UK, have recently intensified the demand for reform. One recent example is a report from the Post-Crash Economics Society at the University of Manchester (Post-Crash Economics Society 2014).
Education Global crisis
education, financial crisis, global crisis, academia, teaching, economics education, undergraduates
Exploring the transmission channels of contagious bank runs
Martin Brown, Stefan Trautmann, Razvan Vlahu 10 April 2014
Contagious bank runs are an important source of systemic risk. However, with observational data it is near-impossible to disentangle the contagion of bank runs from other potential causes of correlated deposit withdrawals across banks. This column discusses an experimental investigation of the mechanisms behind contagion. The authors find that panic-based deposit withdrawals can be strongly contagious across banks, but only if depositors know that the banks are economically related.
Financial contagion – the situation in which liquidity or insolvency risk is transmitted from one financial institution to another – is viewed by policymakers and academics as a key source of systemic risk in the banking sector. In particular, the events in the 2007–2009 Global Crisis have turned the attention of policymakers towards the potential contagion of liquidity withdrawals across banks and the resulting implications for financial stability.
experimental economics, financial stability, financial crisis, global crisis, banking, contagion, banks, systemic risk, bank runs