Title: Understanding the Financial Crisis Presentation to Members of the Town
1Understanding the Financial Crisis Presentation
to Members of the Town County ClubHartford, CT
James Stodder, (Ph.D., Economics, Yale
1990) Lally School of Management
Technology Rensselaer Polytechnic Institute at
Hartford Hartford, Connecticut, USA
2Outline of Talk
- Keynes on Credit Cycles
- - Why we need Regulation
- Where is the Bottom?
- Connecticut is Middle of the Pack
- Government Deficit Spending
- Needed in the Short-term
- But a Big Problem Long-term
3(1) Biz Credit Cycles J. M. Keynes 1883-1946
4US Macro-Stability Better, Room for Improvement
45
55
66
34
Source
http//www.nber.org/cycles.html
5Bad News Bubbles are Endemic
Arlington Williams, Price Bubbles www.indiana.ed
u/arlwilli/pdf20files/bigmkts.pdf
6Good News People Do Learn
V. Smith A. Williams, Experimental Market
Economics, Scientific American, Dec. 92
7The Wisdom of Keynes
- A sound banker, alas, is not one who foresees
danger and avoids - it, but one who, when he is ruined, is ruined
in a conventional way, along with his fellows, so
that no one can really blame him.
- J.M. Keynes (1931)
8- Paradox of Thrift Keynes noted
- Consumers cut back on their spending and save
more during a recession. This only makes the
recession worse. - Similarly for Banks, Loan Loss Reserves (LLR) are
often raised in a recession, just when households
and businesses most need credit ensuring more
collapses and worsening the recession.
9Insurance gt Moral Hazard gtNecessity of
Regulation
- Moral Hazard of Insurance
- If you had a car that is less damaged by any
given car crash would that make you drive
faster? - If you (and everybody else) drove faster, could
this actually wind up making you less safe ?
10www.economist.com/finance/displaystory.cfm?story_i
d12480887
www.nytimes.com/2008/10/03/business/03sec.html
11Limits of Fed Magic
New Yorker, Oct. 2008
12Currency Rises Slightly
13But Bank Reserves up 100-fold
14M0 Currency Reserves 16b
15M1 16b Currency Bank Deposits
16Money Multiplier M1/M0 1
17Bank Money Multiplier
- If l loans, Reserve multiplier is
- D R(1 l l 2 l 8 ) R/(1- l )
- If M0 Reserves (R) Currency (C),
- M1 (Currency Deposits) multiplier is
- M1 C R/(1- l ) M0R R/(1- l )
- M1/M0 1-R R/(1- l )/M0
- So M1/M0 1 gt l 0
18The Zero Bound
19Keyness Liquidity Trap
20Keyness Liquidity Trap
21Keyness Liquidity Trap
22Keyness Liquidity Trap
23Output Gap 20 GDP
- http//www.cbo.gov/ftpdocs/99xx/doc9958/01-08-Outl
ook_Testimony.pdf - A little Stimulus Math
- 20 14 tr. 2.8 tr.
- Stim1.5 2.8 gt Stim 1.87 tr.
24(2) 3 Reasons Bottom stillA Long Way Off
- Housing Recovery probably more than a year away.
- Credit Markets still very weak.
- Stock Market Valuation Ratios like P/E and
Tobins Q are now only at historical averages.
25Housing Bottom A Long Way Off
http//www.nytimes.com/imagepages/2008/10/16/busin
ess/16housing.graphix.ready.html
26Why it Matters to Everyone
27Indicators of Credit Crisis
http//www.nytimes.com/interactive/2008/10/08/ bus
iness/economy/20081008-credit-chart-graphic.html
28TED-Spread Financial Crises
Subprime financial shock
LTCM
Y2K
SL crisis
Peso crisis
Thai baht
Tech bust
Orange County
29108 Years of P/E and Q
Shiller/Smithers - www.ft.com/cms/s/0/099f6380-bb1
f-11dd-bc6c-0000779fd18c.html
30(3) CT is Middle of the Pack
- Fairfield Financial Sector down, but ..
- Conventional Banking and Insurance less
vulnerable than Investment Banks, Financial
Insurance - Defense industries well insulated
- Pharmaceuticals and Biotech have good long-term
prospects - House Price Increases near US Avg.
31- CTs Largest Private Employers, CT payroll
- United Technologies Corp. (UTC) 26,490
- The Stop Shop Cos. Inc. 14,049
- The Hartford Financial Services Group Inc.
13,000 - Yale University 12,100
- Foxwoods Resort Casino 11,900
- Mohegan Sun Casino 10,000
- U.S. Naval Submarine Base 9,900
- Wal-Mart Stores, Inc. 9,038
- ATT Corporation 7,700
- General Dynamics Electric Boat 7,500
- General Electric Co. 7,500
- Aetna Inc. 7,252
- Pfizer Global Research and Development 7,000
- The Travelers Cos. Incorporated 6,500
- Hartford Hospital 6,377
- Bank of America 5,100
- Cigna 3,984
COLOR KEY Defense Health Education Insurance
Banking Counter-cyclical Pro-cyclical
32More Stable than US as a Whole
Source Economy.Com, Connecticut Precis, Sept.
2008
Saturday, November 14, 2009
32
33State Income Growth Comparable
Source Economy.com, CT Precis, Sept. 2008
34State Unemployment Comparable
Source Economy.com, CT Precis, Sept. 2008
35Sun Belt, Rust Belt Concentration
36CT Suffered Less than Most in Northeast
Source Office of Federal Housing Enterprise
Oversight http//www.ofheo.gov/media/pdf/2q08hpi.
pdf
Saturday, November 14, 2009
36
37What doesnt go up too far, Wont go down so far
Economy.com, CT State Report, Sep. 2008
382006 Peak of Price-to-Rent
39(No Transcript)
40Source NY Times, May 28, 2008 Economy.com
41www.bos.frb.org
42US Vacant Homes for Sale (thousands)
Housing supply 900,000 Single 525,000 Multi
300,000 Manufactured 75,000 Housing
demand 1,400,000 Households 875,000 Obsolescen
ce 400,000 Second homes 125,000
Economy.com, Census, Nov. 2008
43(4) More Federal Deficit Spending (not Tax Cuts)
Necessary
- Tax cuts to the rich more likely to be saved, not
spent or invested. - Tax cuts dont have big effect on those too poor
to pay many taxes. - Unmet needs in Energy, Environment, Health, and
Education good reasons to spend.
44Government Must Increase Spending in Severe
Recession
- If the Treasury were to fill old bottles with
banknotes, bury them at suitable depths in
disused coal mines -
- It would, indeed, be more sensible to build
houses and the like but if there are political
and practical difficulties in the way of this,
the above would be better than nothing.
(Keynes, General Theory, 1937)
45But We Need Foreign Coordination for US
Expansion to be Successful
- Benefits of lone expansion leak out, other
countries free ride. - Alternatives to joint expansion are protectionism
and competitive devaluations. - US long-term Fiscal Gap makes lone expansion
untenable.
46Long Term Fiscal Gap Unsustainable
http//www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO
_Testimony.pdf
47Sure as Debt and Taxes
http//www.cbo.gov/ftpdocs/93xx/doc9385/06-17-LTBO
_Testimony.pdf
48Inflation/Devaluation a Powerful Temptation for
Highly Indebted Governments
- Germany after WWI
- Russia after the Revolution
- Soviet Union after the Cold War
- Many Developing Countries after
- spending, investment binges
- (See L. Kotlikoff S. Burns,
- The Coming Generational Storm, 2004)
49Implications of Limited Pass-Through
- Linda Goldberg (FRBNY) has shown that
- Dollar Devaluation means
- Improved Earnings on Foreign Assets
- Easier Debt Servicing
- Smaller Trade Deficit
- And at the same time,
- Minimal Costs in further Inflation
- So - Whats Not to Like?
- FRBNY Governor Frederic Mishkin says
Devaluation cannot be a policy. (I think he
means an explicit policy.)
50Inflation/Devaluation Appears to be a Painless
Way Out of Debt
51Promising Investments?
- Short-Term Shorts (Aggressive)
- Shorts on the Dow, SP (DOG, SH, SDS
- en.wikipedia.org/wiki/Inverse_etf)
- Medium-Term Holds (Cautious)
- US Treasuries (but not long term remember
inflation) - Gold, Silver, other precious metals
- Long-Term Holds (Patient)
- Non-Dollar Assets in Emerging Markets
- Renewable Energy Technology
- Pharmaceuticals tied to global incomes, high
dividends
52Summary of Conclusions
- Recession will be long and deep housing slump,
interbank lending, financial markets likely to
overshoot on low side. - CT is middle of the pack for housing prices and
employment stability. - Greatly expanded federal spending is needed in
the short-term. - Long-term, however, US government debt is
unsustainable. - There are still some places to put your money!