Credit

1
Credit

• Fin254f
• Spring 2010 1.3
• Kindleberger/Aliber (4)
• Reinhart/Rogoff(2)

2
Outline

• Credit and money
• Money mechanisms
• Currency Schools
• Types of credit
• Credit collapse in great depression
• Sovereign debt and serial defaults

3
Money Supply

• What is it?
• Is it exogenous or endogenous?
• How is it connected to credit/collateral?
• M1 demand deposits
• M2 M1 time deposits
• M3 M2 government securities
• Mi etc., etc
• How do you measure?

4
Creating Money

• Investor buys a 1000 AAA MBS (mortgage backed
  security
• Use as collateral to borrow 900
• Buy 900 AAA MBS
• Use as collateral to borrow 810
• ..

5
Collateral and Borrowing

• Reserve requirements
• Amounts banks must hold (not lend) (10-20
  percent)
• Margin requirements
• Amount of own money for stock investors
• 50 today, in 1920s 10-20
• Haircuts
• 1 haircut, means can borrow 1000 - 0.011000
  990
• For AAA securities often low
• During crises can rise dramatically

6
Other Credit Expansion Methods

• Vendor financing
• Tulip bubble
• Reportage
• Speculators in France 1882 (14 days to pay for
  stock purchases)
• Consumer installment credit
• US consumer auto purchases in 1920's

7
Cyclical Credit and Money

• Expansions
• Lending and credit expands
• Collateral levels fall
• New credit technology
• Crises
• Credit dries up
• All effectively monetary disturbances
• Fisher Black and endogenous money

8
Schools of Monetary Thought

• Currency School
• Banking School

9
Currency School

• Hard restrictions on monetary growth
• Like 2
• Eventually became monetarists (Friedman)
• Inflation and monetary growth locked to this
  policy
• No big role for "endogenous money" and credit
• Hesitant about banking/financial restrictions

10
Banking School

• Increases in money and credit natural in
  expansion
• Will generally not overheat
• Driven by increases in business activity

11
Monetary Difficulties

• Too much credit
• Inflation and instability (Currency school!)
• During early growth periods expansion of credit
  necessary
• Banking school!
• How do we balance this?
• How do you eventually shut down credit growth as
  bubbles take off?

12
Defining Money Again

• Problematic
• Cash Deposits short term assets long term
  assets real estate ...
• What about "total credit"?
• Can you measure this?

13
Debt Quality

• Periods of euophoria
• Quantity of debt increases
• Quality falls
• Quality and Minsky (Hedge, Speculative, Ponzi)

14
Debt Instruments

• Bills of exchange
• Vendor finance (seller extends credit to buyer)
• Initially directly tied to goods and shipments
• Later more general
• Were they money?
• Occasionally periods when debts of firms far
  exceeded their net worth
• LTCM 5 billion in capital -gt 125 billion
  assets, 25-1
• Similar ratios in early booms

15
Call Money

• One day loan (origins France 1882)
• Used by security traders for short term liquidity
• France(1882) and US(1920s)
• Supports speculative stock buying
• Increased demands for credit as market rises
• Massive defaults on loans as market falls
• Curbed in 1930s (margin requirements to 50
  percent), but
• Is this different from SP futures traders (10
  percent margin requirement)

16
Gold Exchange Standard

• Central bank holdings of British Pound based
  securities
• Early 1900's
• Country borrows in pounds
• Adds to reserves
• Increases global credit and money supply

17
The Great Depression and Credit

• Competing theories
• Monetary
• Friedman/Schwartz
• Decline in money supply from 29-33
• Keynesian
• Peter Temin
• Consumption and normal consumption
• Real money (M/P) increases, 29-33

18
The Great Depression and Credit

• Industrial production
• June 29 127
• Sept 29 122
• Oct 29 117
• Nov 29 106
• Dec 29 99
• Credit drawn to stock market as rises to peaks in
  October 29
• Credit freezes after stock market crash
• Auto production 660K (March) - 92.5K (December)

19
The Great Depression and Credit

• Trade also collapses
• Loans to finance trade credits drop
• (Classic explanations are protectionism)
• Minsky and Henry Simmons only proponents of
  credit mechanisms
• Simmons policy reco's
• 100 percent currency reserves for banks
• Ban most other forms of lending
• All financial wealth to be equity based

20
Austrians and Money

• Private money issuance
• "Good money drives out bad"
• Several historical experiences suggest otherwise

21
Central Banks and Money/credit

• Can they influence?
• Can they restrain when credit begins to blow up?
• Can they expand credit during a crisis?

22
Sovereign Debt LevelsReinhart and Rogoff (2)

• Troubling debt levels
• Lower for emerging economies
• Recurrent defaults
• Some developed countries high
• Japan 170 of GDP
• Much crises start at lower levels for developing
  countries

23
Developing Examples1970-2008 Extern. Debt/GDP

• Mexico,
• 1982 (47)
• Chile,
• 1972 (31), 1983, (96)
• Ecuador,
• 1984 (68.2), 2000(106), 2008(20)
• Russia
• 1998 (59)
• Turkey
• 1978(21)
• Average 69.3 (gt100 in only 16)

24
Debt Distributions

• Larger for defaulters
• Trouble thresholds depend on many variables
• Troubled history (inflation/repayment) matters a
  lot
• Worse, this is lower is the "debt threshold"

25
Debt and Risk

• Correlations of External Debt/ GDP and
  Institutional Investor ratings
• Generally large and positive
• (Table 2.3, 0.3-0.5, except Middle East 0.14)

26
Debtors Clubs (groups)

• Low risk, low debt
• Type I
• Low risk, high debt
• Type 2
• High risk, low debt
• Type 3
• High risk, high debt
• Type 4

27
Debt Intolerance

• How can countries become debt intolerant?
• Institutions, government, other soft factors
  matter
• Risk sharing by open capital markets may be small
• Capital flows may be procyclical and
  destabilizing (Iceland)

28
Summary

• Crises seem tied to increases in debt
• Public debt and private debt
• Related to monetary control too
• Continue to analyze