Transcript Credit - Brandeis

Credit
Fin254f:
Spring 2010 1.3
Kindleberger/Aliber (4)
Reinhart/Rogoff(2)
Outline
 Credit



and money
Money mechanisms
Currency Schools
Types of credit
 Credit
collapse in great depression
 Sovereign debt and serial defaults
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?
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
 …..
Collateral and Borrowing

Reserve requirements


Margin requirements



Amounts banks must hold (not lend) (10-20
percent)
Amount of own money for stock investors
50 % today, in 1920’s : 10-20 %
Haircuts



1 % haircut, means can borrow 1000 - 0.01*1000
= 990
For AAA securities often low
During crises can rise dramatically
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
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
Schools of Monetary Thought
 Currency
School
 Banking School
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

Banking School
 Increases
in money and credit natural in
expansion
 Will generally not overheat
 Driven by increases in business activity
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?
Defining Money Again
 Problematic
 Cash
+ Deposits + short term assets +
long term assets + real estate + ...
 What about "total credit"?
 Can you measure this?
Debt Quality
 Periods


of euophoria
Quantity of debt increases
Quality falls
 Quality
and Minsky (Hedge,
Speculative, Ponzi)
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 -> 125 billion
assets, 25-1
 Similar ratios in early booms

Call Money
One day loan (origins France 1882)
 Used by security traders for short term
liquidity
 France(1882) and US(1920’s)





Supports speculative stock buying
Increased demands for credit as market rises
Massive defaults on loans as market falls
Curbed in 1930’s (margin requirements to 50
percent), but

Is this different from S&P futures traders (10
percent margin requirement)
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
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
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)

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
Austrians and Money
 Private
money issuance
 "Good money drives out bad"
 Several historical experiences suggest
otherwise
Central Banks and
Money/credit
 Can
they influence?
 Can they restrain when credit begins to
blow up?
 Can they expand credit during a crisis?
Sovereign Debt Levels
Reinhart 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
Developing Examples
1970-2008: Extern. Debt/GDP

Mexico,


Chile,


1998 (59)
Turkey


1984 (68.2), 2000(106), 2008(20)
Russia


1972 (31), 1983, (96)
Ecuador,


1982 (47)
1978(21)
Average 69.3 (>100% in only 16%)
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"
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)
Debtors Clubs (groups)

Low risk, low debt


Low risk, high debt


Type 2
High risk, low debt


Type I
Type 3
High risk, high debt

Type 4
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)
Summary
 Crises
seem tied to increases in debt
 Public debt and private debt
 Related to monetary control too
 Continue to analyze