Download Christina Romer, Chair Council of Economic Advisors

Christina Romer, Chair
Council of Economic Advisors
Speech of September 24, 2009
•Economic History
•Our Great Crisis vs. The Great Depression
•Cheerleading
•Back from the brink
•Recovery underway
•Policy Promotion
•Continued stimulus
•Regulatory initiatives
Vicious Spirals Unleashed
House Price –
Foreclosure
Spiral
Deleveraging – Debt Deflation
Spiral
Demand –
Jobs –
Wages –
Income –
Spiral
Government
Revenue –
Cutback
Spiral
Global Repercussion
Spiral
Macroeconomic Linkages
and
Feedbacks
Vicious Spirals Unleashed
Vicious Spirals Reversed? Tackle them all together!
Refinance
House
Price –
Mortgages
Stimulus
Demand –
Program
Jobs –
•Infrastructure
Spending
Wages –
•Tax Cuts
Foreclosure
Spiral
Deleveraging
Debt Deflation
Revive dual–banking
system
Cash for Trash
Spiral
Income –
Spiral
•Recapitalize banks
•Revive securitization
Federal Aid
Government
To States
Revenue
–
Cutback
Spiral
GGlobal
– 20 Repercussion
•Coordinated
Spiral Stimulus
Macroeconomic
Linkages
Macroeconomic Linkages
and
and
Feedbacks
Feedbacks
Great Depression vs. Great Crisis
1929 – 1939
2008 – 2009
{Lead Up: BOOM  Monetary Tightening} {Lead Up: BOOM  Monetary Tightening}
•Stock market crash, September 1929
•Housing Bubble Burst ~ Fall 2007
•Subprime meltdown  MBS decline
•Fed injects liquidity
•Bear Stearns Bailout
•Fannie/Freddie Bailout
•Lehman collapse, September 2008
•Bank panic (9/30) / Bank of US (12/30)
Do Shocks Compare?
1929 decline in household wealth: 3 %
– Stock market down 14 % for year
2008 decline in household wealth: 17%
– House prices down 9 % for year
– Stock market down 24 %, September – October 2008
– TED Spread Peak: ~ 400 basis points [really 500+ basis points!]
• Is 1929 vs 2008 a fair comparison of wealth shocks?
– Great Depression bank panics started in 1930
– Great Crisis financial panic started in September 2008
Treasury Bill–to–Eurodollar Rate
(TED) Spread
Source: www.federalreserve.gov/releases/h15/data.htm
Great Depression vs. Great Crisis
1929 – 1939
2008 – 2009
{Lead Up: BOOM  Monetary Tightening} {Lead Up: BOOM  Monetary Tightening}
•Stock market crash, September 1929
•Housing Bubble Burst ~ Fall 2007
•Subprime meltdown  MBS decline
•Fed injects liquidity
•Bear Stearns Bailout
•Fannie/Freddie Bailout
•Lehman collapse, September 2008
•Bank panic (9/30) / Bank of US (12/30)
•“Swift and bold” policy responses
•Passive Fed response
•AIG nationalization
•Defend gold! (October 1931)
•Innovative “facilities”
•Discount rate up 2%
 maintain credit flow
•Great Contraction of money supply
•TARP
•Tax increase, 1932
•Fiscal Stimulus
•Treasury Secretary Mellon: “…
•2% of GDP in 2009
liquidate labor, liquidate stocks,
•2 ½ % of GDP in 2010
liquidate the farmer, liquidate real
estate…”
•2009 Stress Tests
•1933 Bank holiday
 Confidence in banks restored
 Confidence in banks restored
2008/2009 Responses
Lender of Last Resort / Spender of Last Resort
•
Tax Rebate $124 bil.
• Fed Fund Rate Cuts
• Fannie/Freddie $200 bil.
•
Bear-Stearns $29 bil.
• AIG $174 bil.
Fed “Facilities”
• Primary Dealer Credit Facility (PDCF) $58 bil.
• Treasury Security Loan Facility (TSLF) $133 bil.
• Term Auction Facility (TAF) $416 bil.
• Asset- Backed Commercial Paper Funding Facility (CPFF) $1,777 bil.
• Money Market Investor Funding Facility (MMIFF) $540 bil.
• More Fed Fund Rate Cuts … Hold At ~0%
• Fed Purchases of Long-Term Securities: GSEs & MBSs $600 bil.
• Term Asset-Backed Securities Loan Facility (TALF) $200 bil.
Emergency Economic Stabilization Act/TARP $700 bil.
Government Loans
Government Equity
Stimulus Package $787 bil.
aka The American Recovery and Reinvestment Act
TARP II
• Stress Tests
Other Stabilizing Forces
• Automatic Stabilizers
• Big G
• Progressive Tax System
• Social Safety Net
{Weaker in US than in Europe  Europe downturn cushioned}
• Anchored inflation expectations
1929 – 1930: Sharp deflation/Deflationary expectations
• Real interest rates and debt burdens up
• Collateral values down
2008 – 2009
• Modest and steady core inflation
• Steady rates on TIPs
• Deposit insurance
Recoveries: 1930s vs 2009
1933 - 1937
• Real GPD growth ~ 10 % per year
• Unemployment rate down 11 points from 25 % peak
Recovery stifled by monetary and fiscal contractions
2009
• Real GDP 7% below potential
– Stimulus raised growth to 2% range
– Stimulus created ~ 1 million jobs above baseline
Okun’s Law: need 2 ½ % growth [or more] for unemployment rate to fall
“ … to talk seriously about stopping policy support at a time when the
unemployment rate is nearing 10% and still rising is to risk nipping
the nascent recovery in the bud.” Christina D. Romer
Financial Regulatory Reform: Then and Now
Legacies of Great Depression
•
•
•
•
•
Banking Act of 1933  FDIC
Securities and Exchange Act of 1934  SEC
Banking Act of 1935  FOMC
Investment Company Act of 1940  Regulate mutual funds
Employment Act of 1946  Activist commitment
Existing flaws
• No regulator evaluates risk to entire system
» Too big to fail / Too interconnected to fail
• Overlapping regulatory agencies  regulatory arbitrage
• No way to resolve major non-bank financial institutions
• Weak consumer protection
Administration Wish – List
• Fed as czar?
• Council of regulators
– Evaluate systemic risks
– Identify emerging financial innovations
• Resolution authority
– FDIC model … insurance premiums based on systemic risk?
• Consumer financial protection agency
Can the Fed do it?
Has the Fed done it????
Other ideas in the air
• Central clearinghouse for ALL derivatives
• “Consumer protection” for sophisticated financial products
• Deferred compensation / “clawbacks”
Dynamics of Financial Crises in
Emerging Market Economies
• Stage one: Initiation of Financial Crisis.
• Path one: mismanagement of financial liberalization
• Weak supervision and lack of expertise  lending boom.
• Domestic banks borrow from foreign banks.
• Fixed exchange rates give a sense of lower risk.
• Securities markets not well-developed  Banks important
• Path two: severe fiscal imbalances:
• Governments force banks to buy government debt.
• When government debt loses value, bank net worth down .
– Additional factors:
• Increase in interest rates (from abroad)
• Asset price decrease
• Uncertainty linked to unstable political systems
Dynamics of Financial Crises in
Emerging Market Economies
• Stage two: currency crisis
– Bank losses  currency crises:
• Government cannot raise interest rates (doing so forces banks
into insolvency)…
• … and speculators expect a devaluation.
• Foreign and domestic investors sell the domestic currency.
•
Stage three: Full-Fledged Financial Crisis:
– The debt burden in terms of domestic currency increases
– Banks are more likely to fail:
• Individuals are less able to pay off their debts (value of assets
fall).
• Debt denominated in foreign currency increases (value of
liabilities increase).
Financial Crises: Mexico 1994-1995
• Financial liberalization in the early 1990s:
– Lending boom, coupled with weak supervision and
lack of expertise.
– Banks accumulated losses and their net worth
declined.
• Rise in interest rates abroad.
• Uncertainty increased (political instability).
• Domestic currency devaluated on December
20, 1994.
• Rise in actual and expected inflation.
Financial Crises: East Asia 1997-1998
• Financial liberalization in the early 1990s:
– Lending boom, coupled with weak supervision and
lack of expertise.
– Banks accumulated losses and their net worth
declined.
• Uncertainty increased (stock market declines
and failure of prominent firms).
• Domestic currencies devaluated by 1997.
• Rise in actual and expected inflation.
Balance Sheet of All Commercial Banks (items as a percentage of
the total, December 2008)
Bank Management
Liquidity Management
Ample excess reserves
Borrow reserves
Discount loans
Federal funds market
Secondary reserves
Reduce loans
Asset Management
Return/Risk/Liquidity
Tradeoff/Balance
Liability Management
Deposits/CDs/Fed funds…
Capital Adequacy Management
Prevent failure
Regulatory requirement
Basel Accord: Risk-based
reqmt
Leverage ratio
Performance Measures
Return on assets: ROA
Return on equity: ROE
Equity multiplier: EM
EM = Assets/Equity Capital
Credit Risk
Screening / Monitoring
Specialized lending
Restrictive covenants
Compensating balances
Credit rationing
COLLATERAL
Interest-rate Risk
Gap and Duration analysis
Off-balance-sheet Activities
Loan sales—Securitization
Fee income: SIVs/Underwriting
Trading income
•Value at risk/Stress
test/Hedges