Transcript Creating Business Value Together!

• Autocatalytic process: the outcome of the process is
itself a catalyst for the process
 Chain Reaction!
• Viking success propelled Viking success.
… but then came Collapse (Jared Diamond)
• Realized profits repay debts … propel more debt
… but then comes collapse (Hyman Minsky)
Minsky’s World
•Quasi – rents: cash flows available to pay debts
•PI – [supply] price of investment goods
•PK – [demand] price of kapital goods
•Borrower’s risk
•Lenders risk
•Hedge finance: E(cash flows) > Payment commitment
•Speculative finance: E(cash flows)<Commitment
… but > Interest commitment  Roll over debt
•Ponzi finance: E(cash flows)<Interest commitment
… Expect to increase debt
•Financial fragility: mix of Hedge – Spec – Ponzi
Good times  Confidence  Risk-taking  Fragility
Minsky’s World – Keynes’ World
Y=C+I
Fluctuations in I  Fluctuations in Y
• Expectations and degree of confidence
• Animal spirits
• Subject to sudden and violent change
• Complex interactions of
decisions/outcomes/liquidity/confidence
Booms and Busts
The Minsky Footprint
Realized expectations  Increased profits & Reduced risk  BOOM
Disappointed expectations  Reduced profits & Confidence Bust
Rush to liquidity  Debt deflation
Pk
Borrower’s Risk
Internal funds
Marginal lender’s risk
Lender’s Risk
PI
Investment
Stabilizing an Unstable Economy
Financial Instability Hypothesis:
•Hedge finance
Two types of risk affect the volume of investment.
•Speculative finance
…The first is the entrepreneur's or borrower's risk
•Ponzi finance
and arises out of doubts in his own mind as to the
probability of his actually earning the prospective
yield for which he hopes. If a man is venturing his
own money, this is the only risk which is relevant.
…But where a system of borrowing and lending
exists, a second type of risk is relevant which we
may call the lender's risk. GT, Chapter 11.
Price of capital assets
Hyman Minsky
1919 - 1996
Student of Simons/Schumpeter
PK
Borrower’s Risk
A Minsky Cycle
•Displacement (invention, easy money)
•Boom…successful speculation
•Euphoria…financial innovation
•Profit taking
•Panic
PI
Internal funds
Io
I1
Investment
When expectations are disappointed,
investment collapses … but debts
remain
Akerlof and Shiller, Animal Spirits
• Confidence – Keynes-Minsky
• Hopes, Exuberance, Fears
• Waves of optimism and pessimism
• Corruption - Bad Faith  Loss of Trust
• S&Ls – Enron – Sub-prime crisis – Goldman Sachs
• Fairness
• Punish cheaters, even at own expense Downward wage rigidity
• Relative position
• Money illusion
• “Illusion” is real in view of nominal contracts/accounts
• Money illusion  Inflation – unemployment tradeoff
“So long as money retains its age-old power to deceive, inflation can be used to
resolve economic conflict.” James Tobin
• Stories
• New eras – Irrational exuberance
Akerlof and Shiller: A brief history of macroeconomics
• Pre – Keynes: Say’s Law  Automatic adjustment to full
employment
• Keynes: Animal spirits  Excesses Inherent instability
Minsky, JMK, Stabilizing an Unstable Economy, Can “It” Happen Again?
• Hicks: IS – LM  Keynes without animal spirits
• Consumption function – Liquidity preference function
• Hydraulic Keynesians
• Original Phillips Curve  Policy Menu
• Friedman: Monetarist counter-revolution
• Dispense with money illusion/enter expectations/natural rate
 Wage Setting: W = PeF(u,z)
• New Classical Economics
• Rational expectations
• Real business cycles (dynamic stochastic general equilibrium)
• New Keynesian Economics
• Rational expectations – but sticky adaptation
Akerlof and Shiller: Prescription for Today
• A Second Target – A Credit Target
“It is fairly easy now to project the fiscal and monetary stimulus
necessary for aggregate demand to be at full employment—if
financial markets are freely flowing…But, with the loss of
confidence in the financial sector, macroeconomic planners must
have a second target…—the amount of credit that would normally
be given [to qualified borrowers] if the economy were at full
employment.”
Methods: Discount window (TALF)/Capital injections/GSEs
• Gotta replace the fallen Humpty-Dumpty (Securitization)
• A Credit Target—Whom to credit?
• Bernanke and Blinder (1988) Credit, Money and Aggregate
Demand, AER, May.
– In liquidity trap, expansion of credit is effective stimulus
Aside: Also in AER, May 1988. Akerlof and Yellen, Fairness and Unemployment
“…where it is advantageous to pay some employees highly, it is also … fair to
pay other employees well.” Unfair pay  shirking
Back to Minsky – Keynes
• Variables:
PK = volatile demand price of kapital asset
PI = sluggish supply price of investment goods
q = expected quasi-rent from the asset
M = quantity of money  ease of credit
c = cash-flow commitment from finance arrangements
ĉ = “acceptable” cash flow commitments
Then, PK = K(q, M, ĉ – c)
“If the demand price of a capital asset … is not less than its replacement
costs, new investment will take place.”
The Minsky Footprint
Realized expectations  Increased profits & Reduced risk  BOOM
Disappointed expectations  Reduced profits & Confidence Bust
Rush to liquidity  Debt deflation
Pk
Borrower’s Risk
Internal funds
Marginal lender’s risk
Lender’s Risk
PI
Investment
A “Global Saving Glut”
The best
of times
Capital Inflows
Easy Money
Policy
Escalating
House Prices
Ambitious
Mortgage Brokers
Eager Home
Buyers
Developer Clout
Innovative
Banks
Bank Regulators
Gov’t Sponsored
Enterprises
Securitization
MBSs
Rating
Agencies
The best
of times
Capital Inflows
Escalating
House Prices
Easy Money
Policy
Ambitious
Mortgage Brokers
Eager Home
Buyers
Developer Clout
Innovative
Banks
Bank Regulators
Gov’t Sponsored
Enterprises
Securitization
MBSs
Rating
Agencies
Financial System Meltdown
At home
Gov’t Supported Takeovers
•Countrywide  BofA
•Bear Stearns  JPMorgan Chase
•Silver State Bank Nevada State
•Merrill Lynch  BofA
•Washington Mutual  JPM Chase
•Wachovia  Wells Fargo
•Security Saving  Bank of Nevada
Interventions/
Nationalizations/
Pre-privatizations
•IndyMac
•Fannie Mae/
Freddie Mac
•AIG
Abroad
•HBOS  Lloyds Bank
•Fortis  PNB Paribus
•Northern Rock
•Royal Bank of Scotland
•Dexia
•Glitnir/Kaupthing/
Landsbanki
Bankruptcies
•New Century Financial
•Lehman Brothers
•Washington Mutual Inc.
Baa-AAA Interest Differential
The Good News: 1932 was worse
The Bad News: This downturn isn’t over until 2010
6.00
5.00
May 32
5.64%
4.00
3.00
2.00
1.00
0.00
Apr 38
3.17%
Sep 82
2.69%
Dec 08
3.38
Responses Lender of Last Resort / Spender of Last Resort
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Tax Rebate $124 bil.
Fed Fund Rate Cuts
Fannie/Freddie $200 bil.
Bear-Stearns $29 bil.
AIG $174 bil.
Fed “Facilities”
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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