Working Papers

2008 10

Long-Run Wealth Accumulation and Household Debt

RBA Deputy Governor Ric Battellino tells the public what Steve Keen won’t:

Australian households have much bigger holdings of financial assets than financial liabilities. Financial assets at 30 June averaged around $275 000 per household while liabilities averaged $150 000 per household. Since then, we estimate that average assets have fallen to around $245 000 per household, though this is still quite a strong position.

This balance sheet structure is very favourable in terms of maximising long-run accumulation of wealth, because the return on these assets over long terms exceeds the cost of debt by a substantial margin. The returns do not, however, accumulate evenly from year to year. Some years produce very strong returns while others produce negative returns.


posted on 30 October 2008 by skirchner in Economics, Financial Markets

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Rudd and Greed

I have an op-ed in today’s Australian responding to the Prime Minister’s attacks on ‘the culture of greed’:

Scottish Enlightenment philosopher David Hume noted as long ago as 1741: “Avarice, or the desire of gain, is a universal passion which operates at all times, in all places and upon all persons.” One cannot explain episodic phenomena such as financial crises with reference to a constant such as human nature or rationality.

The principal mistake the critics of free markets make is to assume that self-interest, greed and irrationality affect only private sector decision-makers. Politicians and regulators are just as prone to self-interested behaviour and do not become saints by virtue of elected or unelected office. The public sector and regulators are populated by the same species that is found in the private sector and financial markets. We should always be suspicious of claims to superior moral virtue coming from politicians.


posted on 29 October 2008 by skirchner in Culture & Society, Economics, Financial Markets

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Greenspan was Right

Alan Greenspan tries to educate a deaf and dumb US Congress, 6 April 2005:

We at the Federal Reserve remain concerned about the growth and magnitude of the mortgage portfolios of the GSEs, which concentrate interest rate risk and prepayment risk at these two institutions and makes our financial system dependent on their ability to manage these risks. Although Fannie and Freddie have chosen not to expand their portfolios significantly this past year (presumably at least partly in light of their recent difficulties), the potential for rapid growth in the future is not constrained by the existing legislative and regulatory regime. It is a reasonable presumption that rapid growth is likely to resume once Fannie and Freddie believe they have resolved their current difficulties. Without changes in legislation, Fannie and Freddie will, at some point, again feel free to multiply profitability through the issuance of subsidized debt. To fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later.


posted on 28 October 2008 by skirchner in Economics, Financial Markets

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Blaming Greenspan

The WSJ is polling readers on the question ‘How much is Greenspan to blame, if at all, for the financial crisis?’  Polling to date suggests that around 25% of readers think ‘He is more to blame than anyone else,’ while 40% maintain ‘He has significant blame.’  Only 10% say ‘he is not to blame.’

The majority view implicitly places an enormous burden on monetary policy to manage, not just inflation outcomes, but a whole range of other policy issues as well, from housing to the regulation of financial markets.  The notion that monetary policy could somehow effectively deal with the multiple regulatory failures implicated in the credit crisis is absurd and goes against everything we have learned about how monetary policy should be conducted in recent decades.  Unfortunately, because monetary policy is seen to have a pervasive influence over the economy, Greenspan makes for an easy target and a simple monocausal narrative for all that went wrong.

It is particularly irksome to see Greenspan having to defend himself against the blame-shifting behaviour of the US Congress.  Afterall, the Federal Reserve operates under a Congressional mandate and is subject to Congressional oversight.  If there were problems at the Fed, then the buck stops with Congress. 

This point about accountability goes well beyond the area of monetary policy.  Politicians and regulators write the rules of the game and are at least notionally accountable for the outcomes under these rules.  The ferocity of attacks by politicians on corporate executives, financial markets and capitalism in general is a transparent attempt to divert attention from their own failings and avoid accountability for their policies.

posted on 24 October 2008 by skirchner in Economics, Financial Markets

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How Freddie and Fannie Fooled Paul Krugman

Charlie Calomiris and Peter Wallison in The Last Trillion-Dollar Commitment: The Destruction of Fannie Mae and Freddie Mac:

Although Fannie and Freddie were building huge exposures to subprime mortgages from 2005 to 2007, they adopted accounting practices that made it difficult to detect the size of those exposures. Even an economist as seemingly sophisticated as Paul Krugman was misled.  He wrote in his July 14, 2008, New York Times column that:

‘Fannie and Freddie had nothing to do with the explosion of high-risk lending…whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.’

Here Krugman demonstrates confusion about the law (which did not prohibit subprime lending by the GSEs), misunderstands the regulatory regime under which they operated (which did not have the capacity to control their risk-taking), and mismeasures their actual subprime exposures (which he wrongly states were zero).  There is probably more to this than lazy reporting by Krugman; the GSE propaganda machine purposefully misled people into believing that it was keeping risk low and operating under an adequate prudential regulatory regime.

Krugman is hardly alone in this.

posted on 23 October 2008 by skirchner in Economics, Financial Markets

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‘Bubbles’ in Everything: Indonesian Seaweed Edition

At least one ‘bubble’ they will be hard pressed to pin on US monetary policy:

a few months ago, parts of the $14 billion global seaweed market started soaring. The price for a key type of Indonesian seaweed suddenly more than tripled, to as much as 18,000 rupiah (or $1.80) per kilogram, from about 5,000 rupiah.

Then, just as quickly, the seaweed bubble burst, adding the spindly plant to the long list of the world’s assets—including oil, stocks and houses—that have tumbled in value. By early September, prices skidded to 12,000 rupiah. By October, they were down to 10,000, and they may be headed lower.

“Nothing like this has ever happened before,” says Asu Hasna, a 42-year-old seaweed farmer in this coastal community on the island of Sulawesi, which, along with parts of the Philippines, is a tropical seaweed hot spot. Before, she says, seaweed prices never fell. “These are bad times.”

Despite recent declines, prices are still higher than they were a year ago. But the recriminations over what went wrong have begun, complete with calls for more government involvement, efforts to make the industry more transparent and reforms to restore market confidence.

posted on 21 October 2008 by skirchner in Economics, Financial Markets

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A Failure of Understanding

Terry McCrann continues his efforts to educate the punditocracy on the relationship between the official cash rate and retail lending rates:

What has never been understood, not just by the general public but by even the supposed literati—politicians and the economentariat—is that the Reserve took those bank increases into account in deciding the official changes. If they hadn’t happened, official rates would have gone higher.

The associated failure to understand, is that the Reserve quite deliberately set out to slow the economy. We didn’t stumble by mistake into this slowdown.


posted on 18 October 2008 by skirchner in Economics, Financial Markets

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The Not So Secret Life of Nouriel Roubini

Way too much information from Gawker.

UPDATE: ‘Nick Denton Is An Anti-Semite With A Nazi Mind’.

UPDATE II: ‘A bunch of wimps’.

posted on 16 October 2008 by skirchner in Economics, Financial Markets

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The Wrong Plan for Australia

I have an op-ed in today’s Wall Street Journal on the Rudd government’s fiscal stimulus package.

posted on 15 October 2008 by skirchner in Economics, Financial Markets

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Governments are Making Things Worse

Jonathan Macey, writing in the WSJ, calls for an end to the demonisation of markets:

Despite all the hard work and good intentions on the part of our public officials, when economists and historians look back on the current financial crisis they are likely to conclude that government intervention prolonged and deepened it. In particular, officials at the Federal Reserve, the Securities and Exchange Commission and the Treasury Department are to blame for publicly losing confidence in the very economic system they are supposed to protect.

The Fed, the Treasury and the SEC appear to be in a state of panic. A crisis mentality led the custodians of the U.S. capital markets publicly to jettison their lifelong commitments to the capital markets in favor of a series of short-term regulatory quick fixes…

Letting markets work is messy and costly. Nevertheless, the only sensible way to deal with the current crisis is to force the companies who created the mess to bear at least some of the costs of their mistakes. Most of all, if the markets are to get back on track our regulators must put an immediate stop to their current practice of publicly demonizing the markets and work to restore confidence in the system.

posted on 11 October 2008 by skirchner in Economics, Financial Markets

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US 2009 Depression

For the truly bearish, Intrade launches a US 2009 depression contract.  Depression is defined ‘as a cumulative decline in GDP of more than 10.0% over four consecutive quarters… Negative quarters in the preceding year will count towards the total GDP decline for expiration purposes.’

The contract is yet to trade, but the bid-ask is 5.1/15, with most of the volume on the short-side.

posted on 08 October 2008 by skirchner in Economics, Financial Markets

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RBA Once Again Shows the Irrelevance of RMBS Intervention

The statement accompanying today’s 100 bp easing in the official cash rate by the Reserve Bank once again makes explicit that the RBA calibrates monetary policy to changes in retail interest rates:

the Board judged that a material change to the balance of risks surrounding the outlook had occurred, requiring a significantly less restrictive stance of monetary policy. The Board also took careful note of movements in funding costs in wholesale markets. Having weighed these considerations, the Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers.

The RBA has always acknowledged that it is the average level of market interest rates over time that matters for the transmission of monetary policy.  Much of the commentary on the extent of pass through by the banks has ignored this obvious point.  Unfortunately, it is easier to bash the banks than to explain how monetary policy actually works.

Today’s announcement also shows the RBA can deliver a more substantial easing in credit conditions than could ever be achieved through government intervention in the market for residential mortgage-backed securities.  The best way for the RBA to pull the rug out from under the RMBS interventionists is to be even more explicit about the extent to which it is discounting government policy in setting the cash rate.

posted on 07 October 2008 by skirchner in Economics, Financial Markets

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