1 / 27

2008 Macrofinance crash

2008 Macrofinance crash. Explanations & Questions. Stock Crashes in 20 th and 21rst Centuries. U.S. Stock Crashes and Macroeconomic Events. Can Financial Events Cause Macroeconomic Problems?. “Payments crises” (liquidity crises) Debtors (first level) stop payments

serge
Download Presentation

2008 Macrofinance crash

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. 2008 Macrofinancecrash Explanations & Questions

  2. Stock Crashes in 20th and 21rst Centuries

  3. U.S. Stock Crashes and Macroeconomic Events

  4. Can Financial Events CauseMacroeconomic Problems? • “Payments crises” (liquidity crises) • Debtors (first level) stop payments • Lenders (first level) income drop, reduce payments on short term loans • Short-term (money market) lenders income drop, reduce payments … • Consumption/Investment effects • Wealth (balance sheet) effects: firms, households reduce consumption/investment as wealth decreases • Debt/Income ratios: solvent firms, household reduce consumption/investment to bring debt to income ratios down

  5. Framework for Thinkingabout Debt and Macro Outcomes • Infinite Horizon Economy Budget Constraint: PV Income + PV Debt = Debt Service + PV Consumption • “NPG” Condition: Over the long run income funds consumption (not debt) • Entire economy faces a budget constraint just as households or government • Sustainable Long Run Relationship: • Income – Consumption – Debt Service >= 0 • Income Growth > Interest Rate on Debt

  6. Example Calculations on Sustainable Debt/Income Ratios

  7. Aggregate U.S. Debt and Debt/GDP Levels

  8. Mortgage Debt only Part of the Story:Commercial Lending a Bigger Part

  9. Debt Growth in 2000s High Relativeto Prior (growing) Trend

  10. Case Study of U.S. Debt $11 Billion City Center Project Las Vegas – MGM Mirage Bank Loan/Bond Funded

  11. 1920s Equity “Bubble & 2000s Debt “Bubble”:Same Story, Different Financial Instruments • Whether Debt-instrument (bond, loan) funded or Equity (stock) funded, ultimate value is net revenue stream from project (Modigliani-Miller Theorem) • High Debt or Equity values imply high expected future net revenue • Consider 2 Scenarios for City Center (at $10B nominal value) • Case 1: $9B in Shareholder Equity with $1B in bank debt; • Case 2: $1B in Shareholder Equity with $9B in bank debt: • Actual PV of future net revenue of project = $5T • With project bankruptcy: • Case 1: Bank claims bankruptcy value = $1B • Original shareholders lose $9B • New shares issued worth $4B • Loss in balance sheets = $5B • Case 2: Bank claims bankruptcy value = $1B • Shareholders lose $1B • Bank loses $8B in value up front; issues new stock and regains $4B • Loss in balance sheets = $5B • In both cases, assets on balance sheets over-valued by $5T; purchases made with this “leverage”

  12. 1920s: Stock Valuations Indicating Very High Net Revenues to Make Sustainable

  13. Common Explanations • Long Run Problems: Mortgage markets overvalued • Fed & other gov’t guarantees (moral hazard) pushing mortgage markets • Fed supplied too much money to markets in early 2000sseparating “systemic” v. non-systemic problems • Poor pricing models separating “systemic” v. non-systemic problems pushing too much money into mortgage markets • Short Run Sparks • Uncertainty about Fed reaction • Lack of Fed reaction (2007-08) • Marked-to-market accounting for mortgages

  14. Evaluating “Policy Uncertainty” Thesis:Financial Stress Appearing Long Before Sept 08

  15. Why So Much Attention on Mortgage Debt? • See mortgage debt as leading indicator, not as only cause • Fire analogy: room with fire in it first does not tell you about the fuel and match • Mortgage debt securitized-tradeable; • Quickly reflecting change in valuations • Commercial bank loans non-tradeable; • Held at bank estimated values for longer

  16. Causes of Debt/GDP Expansion:Cheap Credit

  17. Cheap Credit:Fed Responsible?

  18. Cheap Credit: Public Sector Supply

  19. Cheap Credit: Private Sector Supply

  20. Cheap Credit: Increasing Leverage

  21. Cheap Credit:Inflow of Foreign Capital

  22. Role of Foreign Capital?

  23. Cheap Credit: Innovations? • Securitization, e.g. CDOs • Pooling mortgage (other debt) risk (CDOs, SPVs) • Credit Insurance • Transferring Risk (CDS) • Cochrane: can shuffle risk around, but not change total amount • Evaluation: • CDOs, CDS actually relatively small versus size of overall debt growth

  24. Marked-to-Market Accounting? • How big of an effect is possible from MTM pricing of banks? • See SEC Dec. 2008 Study www.sec.gov/news/studies/2008/marktomarket123008.pdf • 31% of bank assets MTM • 22% of these impact income statement • Part of this amount in Treasuries • Differences in MTM and “amortized cost” • If 20% difference, then 4.4% impact on income • Currently, using “amortized cost” method • Citi assets increase by apx. $3B (out of $1.2T) • BoA assets increase by apx. $9B (out of $1.4T)

  25. Solutions? • Cochrane: • Specify systemic risk for Fed, limiting TBTF • Stiglitz, … • Limit financial innovation • More stringent oversight • Poole, Bullard, BG, … • Raise equity standards • Limit financial firm size • Charge insurance fee based on size • Explicit size limitations

  26. Higher Equity Standards the answer?Modigliani-Miller Theorem: Capital Structure Irrelevance • No difference of debt v. equity (ownership shares) financing of projects if • Asset prices move with statistical independence; • Asset prices are information based without systematic errors; • Taxes treatment of both sources is the same • Bankruptcy treatment of both is the same • No asymmetry of knowledge among borrowers, lenders, shareholders • Implies capital structure matters to the degree that these conditions matter

  27. Debt-GDP Ratios 20s/30s v. 2000s

More Related