Posts Tagged ‘financial crisis’

There’s Hope

October 27, 2009

When I read that McDonalds abandons Iceland, I thought that there’s still hope after the recent financial breakdown:

Iceland’s McDonald’s Corp. restaurants will be closed at the end of the month after the collapse of the krona eroded profits at the fast-food chain …

The story also states that Norway has the most expensive Big Macs:

The most expensive Big Macs are sold in Switzerland and Norway, where the burger costs about $5.75, according to the Economist 2009 BigMac index. The cheapest are sold in South Africa, $1.68, and China, $1.83, the index shows.

Hat-tip: Marginal Revolution

Iceland in Crisis

March 9, 2009

Since Iceland is one of Norway’s neighbors and since my supervisor is Icelandic, I found this article about the financial mess on Iceland quite interesting. It’s called ‘Wall Street on the Tundra’ (another title I don’t quite understand; to call Iceland Wall Street is, well, strange, I think, and while tundra may be exotic, what does it have to do with the financial trouble?), and the introductory paragraph goes like this:

Iceland’s de facto bankruptcy—its currency (the krona) is kaput, its debt is 850 percent of G.D.P., its people are hoarding food and cash and blowing up their new Range Rovers for the insurance—resulted from a stunning collective madness. What led a tiny fishing nation, population 300,000, to decide, around 2003, to re-invent itself as a global financial power? In Reykjavík, where men are men, and the women seem to have completely given up on them, the author follows the peculiarly Icelandic logic behind the meltdown.

Among the more amusing paragraphs, you’ll find the following caricature of how Icelandic banks operated:

You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets.

The author (Michael Lewis) also comes up with an interesting theory of why so few seemed to foresee the global economic downturn:

One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem.

Hat-tip: Freakonomics

UPDATE: My Icelandic supervisor made me aware of a more informative and analytic story on the Iceland crisis from the Wall Street Journal.

Jim argues for an inflation target

November 25, 2008

Jim Hamilton argues that the Fed should adopt an inflation target to get to grips with the current economic situation in the US. This is interesting. Norway’s central bank officially adopted an inflation target of 2.5%  in, I think, 1999. Jim has earlier made it clear that the standard measures the Fed usually use to govern the economy is failing; I reported on this earlier. Jim describes inflation targeting as ‘Plan C,’ and discusses why previous plans have failed. The reason why he sees it necessary to dig deep is the latest report on the Consumer Price Index. The report is dramatic; it shows that prices fell by 1% in October. It may sound innocent, but it amounts to 12% over a year. And it may get worse before it gets better. Jim admits that the Fed is running out of options, but he also thinks targeting inflation is a powerful measure that will work;

Targeting inflation is not just another arrow in the quiver; it’s a bazooka, at least for purposes of preventing deflation. Time to take aim and fire.

A sick system

November 19, 2008

Talking of paradox, it may seem paradoxical that when I comment on economic issues here on the blog, I mostly comment macroeconomic issues; I am a resource and environmental economist, or more generally a microeconomist. Anyway, the Fed funds rate in the US has shown anomalous behaviour the last few weeks. Jim explains: The Fed funds rate is the interest rate at which institutions lend their deposits held in accounts with the Federal Reserve to one another overnight. Currently, the Fed is offering a 1% interest rate on such deposits, but the effective market rate is hoovering around 0.35%. This seems paradoxical (both ironic and illogical):

If you’re a bank and there’s a GSE out there willing to lend fed funds at 0.35%, how much do you want to borrow? Let’s look at the math. If you borrow $1 billion, you pay 0.35% interest and earn 1.0% from the Fed for just holding those funds overnight, from which you’d net $6.5 million over the course of a year. If you borrow $10 billion, you’ll earn $65 million. Totally risk-free, $65 million for your bank as pure profits. Here’s the question– How much would you like to borrow?

Me, I’d like to borrow a few gazillion.

The market does not work. A possible explanation is that carrying out the necessary transactions to take advantage of the situation, banks would see their leverage ratio decrease. Leverage has become (more) painful to banks after the financial breakdown in September. Jim comments:

I have to say that if this is the explanation, it is profoundly disturbing to me. If banks indeed are finding themselves hamstrung to the point that they are unwilling to pick up millions of dollars that are just lying around on the sidewalk, absolutely risk-free, then how can they possibly be expected to function in their traditional role of funneling capital to legitimate investments that all necessarily entail some risk? If this is indeed what is going on, we should be looking at the spread between the effective fed funds rate and the interest rate paid on excess reserves as another indicator of a profoundly sick financial system […]

Recession numbers

October 20, 2008

James D. Hamilton is one of my favourite economists. He has written a great book on time series, and while in California I was lucky to sit in on his econometrics class; he is a fabulous lecturer. On his blog Econbrowser he offers analyses and comments to current economic conditions and policy. In a recent post he discusses numbers that indicate that the US economy is in a recession (industrial production fell by 33.6% (annual rate) in September). More interesting, however, are the comments to the post where a reader asks whether academic economists did (or didn’t do) their job to warn about the possibility of the severe economic breakdown that seemingly is happening in the US. Underlying this question is the much bigger question of whether (macro) economists know what they’re doing.

I find the critique against academic economists misplaced. Many of the best economists work in the financial sector and in related governmental agencies, and neither these nor the academic economists were able to forecast the current crisis. (Well, as Jim points out, several economists did warn of potential danger. The sheer size of it, however, was seemingly not predicted with enough confidence.) There is no reason to believe that academic researchers are better at forecasting than those employed in the financial sector. (Those in the finance sector would not necessarily publish their forecast, but if any of them had any reliable forecasts of the crisis we’re in, their companies would have positioned themselves relative to that, and it seems that none of the Wall Street companies had done so.) This also tells of the extreme difficult of forecasting in economics.

A positive take on the (US) economy

October 16, 2008

I don’t know why I even bother, but I still keep an eye on the unfolding crisis. Casey B. Mulligan has written a rather optimistic op-ed in The New York Times where he claims that it is not necessary to rescue the economy because it is stronger than what it might seem. And it would not suffice to bail out the banks if necessary anyway; he dismisses the bailout plan. And by arguing that the economy is strong and not that dependent on banks, he calls of the announced depression at the same time. Given the gloom reported in most newspapers, this must be said to be rather optimistic. I gather that we live in the short term and are all dead in the long run, Mulligan argues that a short term banking crisis does not necessarily matter much:

And if it takes a while for banks and lenders to get up and running again, what’s the big deal? Saving and investment are themselves not essential to the economy in the short term. Businesses could postpone their investments for a few quarters with a fairly small effect on Americans’ living standards. How harmful would it be to wait nine more months for a new car or an addition to your house?

Also, this post on the Environemental Economics blog points out that the stock market has given a handsome return over the last 60 years even after the recent turmoil. So, cheer up, folks!

Piled Higher & Deeper (PhD Comic)

October 7, 2008

As I am a PhD Student in economics  it may not be surprising that I find the PhD Comic very funny. It originates from a student newspaper published at Stanford University in the US, I think. The comic is set among a group of PhD Students in computer science or thereabouts, but PhD Students (or grad students as they are called in the US) from any field, former or present, will probably recognize most of the stuff going on. To everyone else it offers a glimpse of some of the troubles most PhD Students struggles with at some point or another.

This strip and the next (click on ‘next’) addresses the financial crisis (I had to mention those). The second strip is certainly food for thought! (Any suggestions on what the graph can tell about the quality of people going into PhD studies?)

And here is the first of five consecutive strips about a visit to CERN and the largest particle accelerator in the world. The strips were published around the time when they started up a new series of experiments held to produce dooms day; not a coincident I guess.

My last post on the crisis (yeah right)

October 3, 2008

As most recurring news event, the crisis has started to bore me. I cannot help but bring attention to Joseph Stiglitz latest comment on the bailout still, published at the Economists’ Voice.

One reason I think Stiglitz’ views are interesting is that he argues how I did myself in a recent conversation: The bailout does not address the fundamental problem; all the bad loans. Instead, a rescue operation should help homeowners in trouble. According to Stiglitz, this could be done rather quickly and the measures he proposes would be a lot cheaper than bailing out Wall Street.

Earlier I wrote about the problem the managers of the bailout funds will face valuating the rotten assets, and a possible solution.  As Stiglitz points out, paying a fair price for the bad loans will not fill the hole in the banks’ balance sheets. The solution of a decentralized bailout, thus, is clever, but it would work oposite to the overall goal with the bailout.

Stiglitz concludes that the American taxpayer will in all likelihood have to suffer. He goes on to ponder what only some of the bailout money could do; health care for children for example. Over on the Environmental Economics blog someone commented on what a billion dollars to each of 700 American universities could do to the education sector. In conclusion, Stiglitz does note think the (just voted through Congress) bailout is sufficient. It annoys, then, that he still think it makes sense to go ahead with the bailout. I beg to differ.

Time to act?

October 1, 2008

In this comment Martin Wolf conveys his opinion on the failed bailout. He says he understands why the congress turned it down, but also that the decision was a mistake:

It [Congress’ failure to ratify the bailout plan] is understandable because the use of taxpayer money to buy so-called “toxic” mortgage-backed securities from the greedy fools who created the crisis is hard to tolerate. It is also understandable – even creditable – that those Republicans hostile to “socialism” do not want to bail out the undeserving rich, at least before an election. It is understandable, too, because, for reasons I put forward last week, the plan is not convincing. It is designed to deal with a problem of illiquidity in what seems certain to be a growing crisis of insolvency, particularly as house prices fall and the economy continues to weaken.

Yet the rejection is grossly mistaken because the resulting ruin will hurt the weak and destroy the legitimacy of the market economy. The plan is indeed flawed. But failure to ratify it is unlikely to convince anybody that something better will be forthcoming. It will convince them [who?], instead, that the US is choosing to be impotent. At a time of such fragility, when the insurance offered by government is most indispensable, this is the worst possible message. It is a pity Mr Paulson did not choose another plan. It is a pity, too, that a former titan of high finance was charged with bailing out Wall Street. Yet it was still a mistake to reject the plan. It was necessary, instead, to build upon it.

I am not sure I agree that any medicine is better than no medicine. Particularly not when the doctor may have better stuff in his laboratory. I do certainly not understand his claim later in the comment that first it is necessary to resolve the crisis, and think about the long term consequences of the settlements later. Anyway, Wolf thinks it is time to act:

Government must start to show it is in control of events. In the twilight of a failed US administration, that may seem far too much to ask. Winston Churchill, Roosevelt’s partner, said: “The United States invariably does the right thing, after having exhausted every other alternative.” The alternatives are now exhausted. It is time for politicians to do the right thing.

I found the caricature that accompanied the article funny and to the point. It remains to see whether it is water or gasoline he has in the pipes.

More on the financial crisis

September 30, 2008

I am not a regular on the Freakonomics* blog, but I surf by every now and then. Nowadays the financial crisis in the US and Europe is of course in focus. This piece by Erik Hurst has an interesting discussion of why a vibrant banking sector is necessary and a review of the history of bank regulations in the US. He pinpoints that earlier deregulations reduced interest rates and gave more people access to credit. The demands for more regulation that has surfaced during the current crisis concerns Hurst as he is afraid that the (social) costs these regulations may impose would not get the appropriate attention.

On my part, I wonder what kind of regulations people have in mind. Laws against subprime lending? I think that would lead to overly complicated regulations impossible to enforce. But somehow putting a ceiling on the risks a bank is permitted to take do make sense. As the government insure deposits there is risk of moral hazard.

There is more interesting stuff on the Freakonomics blog. Here is a discussion of an alternative plan for the proposed bailout. The idea, conceived by Lucian Bebchuck, is as brilliant as it is simple and straightforward. One of the problems with the bailout plan that was voted down by congress last night is that the price paid for assets is ‘unfair.’ A solution is to divide the money to be injected between different managers and let them compete:

Suppose that the economy has illiquid mortgage assets with a face value of $1,000 billion, and that the Treasury believes that the introduction of buyers armed with $100 billion could bring the necessary liquidity to this market.

The Treasury could divide the $100 billion into, say, 20 funds of $5 billion and place each fund under a manager verified to have no conflicting interests. Each manager could be promised a fee equal to, say, 5 percent of the profit its fund generates — that is, the excess of the fund’s final value down the road over the $5 billion of initial investment. The competition among these 20 funds would prevent the price paid for the mortgage assets from falling below fair value, and the fund managers’ profit incentives would prevent the price from exceeding fair value.

* Freakonomics is a blog based on the same ideas as the book by the same name (that is, a blog developed from a book, oposit to the recent trend of books based on popular blogs). The book is a demonstration of both the power of microeconomic theory (combined with statistics) and the talent of Steven D. Levitt. I recommend the book to anyone sligthly interested (in economics, or, more extraordinary, Levitt himself for that matter) or just generally curious.

An F.A.Q. to the financial crisis

September 22, 2008

Here is an F.A.Q. to the financial crisis that currently unfolds in the US and the rest of the world. It was posted on the Freakonomics Blog. The authors explain the recent events, for example why the Federal Reserve chose to save Bear Sterns but not Lehman Brothers. They also discuss how Freddie Mac and Fannie May not exactly did what they were supposed to do (reduce mortgage costs to homeowners), but rather glazed their own pie. An interesting read, check it out.