Good Afternoon 1129

1
Good Afternoon (11/29)

• Finish Asian Crisis
• Begin Russian Financial Crisis

2
Some Business

• Please try your best to have stock trak stuff
  done and handed in on Thursday.
• Movie and evals today
• Hail Mary should you throw a pass???
• Neat Discount rate article posted

3
Asian Crisis Terms (shut off projector and do
these on board

• Chaebol
• Crony Capitalism
• Japanese Model
• IMF

• Moral Hazard
• Excess Capacity Glut
• Capital Flight capital inflows to US
• Asian Monetary Fund

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Asian Crisis Terms (cont)

• Exchange
• Stabilization Fund
• Hubris
• Credibility
• Secrecy

• Corruption
• Transparency
• Credit Agencies Credit Ranking
• Economies of Scale

5
Asian Crisis Terms (cont)

• Favoritism
• Exclusivity
• Unhedged Foreign Debt
• Interest Rate Differential

• Currency Pegs
• Command and Control
• Lax Banking Regulations
• Capital Controls
• Below Market Interest Rates

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Introduce the Russian Crisis

• Historical context weathered the Asian Crisis
  much better than expected
• Discuss the Feds outlook at the time
• The 180 degree turnaround

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(No Transcript)
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The Russian Crisis

• You had an immediate and substantial collapse in
  risk appetite. Holders began selling bonds from
  South Korea, Greece, Turkey, Mexico, Brazil.
• Can we see the collapse in the following picture?

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Discuss Fed Fumble article

• What was the Fumble and what was the recovery?
• The handful of Fed policy makers who had argued
  for a more dramatic half-percentage-point rate
  cut felt vindicated. Officials at the Federal
  Reserve Bank of New York worried that the rate
  cut had done little to reverse a stampede away
  from risky, and even not-so-risky, bonds.

11
Fed Fumble Article - continued

• I thought the amount was irrelevant, says Mr.
  Boehne, the Philadelphia Fed president. The
  problem with 50 basis points-jargon for a half
  percentage point-was that people could have
  inferred that we knew more bad things than we
  did. Mr. Greenspan made the same argument
  internally.

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Fed Fumble - cont

• But after the Feds Sept. 29 announcement, the
  stock market sagged, and the worrisome spreads in
  the bond market widened.
• A week later, Mr. Greenspan delivered a rambling,
  off-the-cuff early morning speech to the National
  Association for Business Economics. He had two
  goals. The first was to dispel the sense of doom
  and gloom that had descended.

13
Fed Fumble - contd

• The second goal, somewhat at odds with the first,
  was to lay the foundation for another rate cut by
  detailing the evidence that uncertainty and fear
  were causing investors to, as he put it,
  disengage.
• This is referred to as jaw boning the Fed Jaw
  Bones the Market all the time
• Criticize George W ??

14
Fed Fumble - cont

• By Thursday, Oct. 15, Mr. Greenspan figured the
  spreads in the bond market he had been tracking
  had grown so wide that they were bound to begin
  to narrow soon. It was time. He convened a
  telephone conference call of the FOMC.

15
Fed Fumble

• On their TV sets and computer screens, Fed
  officials watched the instant analysis with a bit
  of trepidation. But the reaction was almost
  universally favorable, and the intended message
  was received The Fed was prepared to do what was
  necessary. Yes! one Fed governor said late that
  afternoon after listening to a Wall Street pundit
  on CNBC, the business cable channel. They got
  it right.

16
What is a spread?

• In the context of the Russian Crisis, people were
  very interested in the movements of the
  commercial paper US T-bill spread (paper bill
  spread for short)
• Why is there a spread?
• Which rate is higher and why?

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Example with numbers

• Suppose the current yield (or rate) on the 3
  month US T-bill is 5.00 and the current yield on
  90 day commercial paper is 5.50
• The difference 5.50 5.00 0.5 is referred to
  as the paper bill spread
• Historically, 0.5 is a low paper-bill spread
• What does a low spread indicate?
• Suppose both rates are the same whats the
  implication?

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The Spread and the crisis

• The Risk aversion (the psychology of going from
  one side of the boat to the other) resulted in
  investors shunning away from commercial paper a
  credit crunch
• Importance For most large, highly rated
  corporations, the commercial paper market is now
  the primary source of short-term credit

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The Spread and the crisis contd

• The shunning away from paper resulted in lower
  prices which is the same as saying higher yields
  on paper
• At the same time investors flocked to the safe
  haven of US Tbills WHY?
• Result prices of Tbills skyrocketed or
  equivalently yields plummeted
• Implications on spread?

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With numbers

• Before crisis paper bill spread 0.5 with
  paper yielding 5.5 and the bill at 5.00
• At worst of crisis paper bill spread 1.9
  Yield on paper 5.5, yield on bill 3.6
• Why didnt yield on paper rise indicating
  investors unwillingness to buy?
• Think of volume rather than price
• Some Pictures

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Commercial Paper Tbill Spread
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US 3 month Tbill
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Yields on Corporate Bonds vs US Tbills
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Spreads rates on corporate bonds minus rates on
Tbills
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Commercial Paper Tbill Spread
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Before getting to picture, discuss the federal
funds market
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(No Transcript)
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Key Terms

• Margin and collateral calls
• Lack of liquidity - markets seized up
• increase in the paper-bill spread
• back up line of credit
• diversity of credit markets - its like having a
  spare tire - Japan and E. Asia dont - Europe?? -
  Sweden

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Greenspan Excerpts

• Following the Russian default of August 1998,
  public capital markets in the United States
  virtually seized up. For a time not even
  investment-grade bond issuers could find
  reasonable takers.

30
Greenspan Excerpts

• Arguably, at least as relevant was the existence
  of backup financial institutions, especially
  commercial banks, that replaced the
  intermediation function of the public capital
  markets.
• When American banks seized up in 1990, as a
  consequence of a collapse in the value of real
  estate collateral, the capital markets, largely
  unaffected by the decline in values, were able to
  substitute for the loss of bank financial
  intermediation.

31
Greenspan Excerpts

• The speed with which the Swedish financial system
  overcame the crisis offers a stark contrast with
  the long-lasting problems of Japan, whose
  financial system is the archetype of virtually
  bank-only financial intermediation. The keiretsu
  conglomerate system, as you know, centers on a
  main bank, leaving corporations especially
  dependent on banks for credit.

32
Greenspan Excerpts

• Thus, one consequence of Japans banking crisis
  has been a protracted credit crunch.
• The failure to have backup forms of
  intermediation was of little consequence. The
  lack of a spare tire is of no concern if you do
  not get a flat.

33
Greenspan Excerpts

• Despite its close trade and financial ties to
  Asia, the Australian economy exhibited few signs
  of contagion from contiguous economies, arguably
  because Australia already had well-developed
  capital markets as well as a sturdy banking
  system. But going further, it is plausible that
  the dividends of financial diversity extend to
  more normal times as well.

34
Greenspan Excerpts

• The addition of distinct capital markets outside
  of banking systems is possible only if scarce
  real resources are devoted to building a
  financial infrastructure. It is a laborious
  process whose payoff is often experienced only
  decades later.

35
Greenspan Excerpts

• It is thus not a simple matter to append
  financial infrastructure to an economy developed
  without it. Accordingly, full convergence across
  countries of domestic financial infrastructure or
  even of the international components of financial
  infrastructure is a very difficult task.