Kevin Erdmann — Leverage is not a sign of risk seeking, a continuing series

A contrarian view.

Idiosyncratic Whisk
Leverage is not a sign of risk seeking, a continuing series
Kevin Erdmann

The Arthurian — TFP: "Understanding what is driving the slowdown is key"

Art continues the argument.

"It's the debt, stupid."

Debt is financial cost, and it influences total factor production (TFP).

As Neil Wilson observed in a comment to another post:

The main argument against monetary policy and magic central banks is straightforward. It requires the expansion of private debt. Which is both endogenous and unstable. The whole theory on which magic central banks is based expects debt to be exogenous and stable.

That sums it up. Leverage works both ways.

The New Arthurian
TFP: "Understanding what is driving the slowdown is key"

The Arthurian

Eric Tymoigne — Money and Banking Part 7

Given that the concept of leverage will be used often in the upcoming posts, this post spends some time explaining what leverage is and some of its impacts on the balance sheet of any economic unit.

New Economic Perspectives
Money and Banking Part 7
Eric Tymoigne | Associate Professor of Economics at Lewis and Clark College, Portland, Oregon; and Research Associate at the Levy Economics Institute of Bard College

Òscar Jordà, Moritz Schularick, Alan Taylor — Leveraged bubbles

The risk that asset price bubbles pose for financial stability is still not clear. Drawing on 140 years of data, this column argues that leverage is the critical determinant of crisis damage. When fuelled by credit booms, asset price bubbles are associated with high financial crisis risk; upon collapse, they coincide with weaker growth and slower recoveries. Highly leveraged housing bubbles are the worst case of all.

Ya think?

Conclusions: Bubble trouble

In this column, we turned to economic history for the first comprehensive assessment of the economic risks of asset price bubbles. We provide evidence about which types of bubbles matter and how their economic costs differ. Our historical analysis shows that not all bubbles are created equal. When credit growth fuels asset price bubbles, the dangers for the financial sector and the real economy are much more substantial. The damage done to the economy by the bursting of credit boom bubbles is significant and long lasting.

In the past decades, central banks typically have taken a hands-off approach to asset price bubbles and credit booms. This way of thinking has been criticised by some institutions, such as the BIS, that took a less rosy view of the self-equilibrating tendencies of financial markets and warned of the potentially grave consequences of leveraged asset price bubbles. The findings presented here can inform ongoing efforts to devise better macro-financial theory and real-world applications at a time when policymakers are still searching for new approaches in the aftermath of the Great Recession.

VOX.eu
Leveraged bubbles
Òscar Jordà, Moritz Schularick, Alan Taylor
ht Lambert Strether at Naked Capitalism

Flaws In Our Policy Operations Run Far Deeper Than Just Neglected Currency Operations

   (Commentary posted by Roger Erickson)



We're 80 years on from the last time we significantly revamped fiscal policy operations, and a few economic ideologues are JUST beginning to punch their way out of a wet paper bag? All while selfishly preening, hogging the spotlight, and effectively demanding that 320 million people halt all public discourse and pay attention to their tiny voices?

No wonder there really IS a mind-boggling failure in situational awareness.

And yes, these ideologues are fully several paradigms behind the times.

Yet there's another, far deeper issue, that looms behind these symptoms. Our electorate itself is collectively so far behind that it doesn't even elect or listen to it's own, ample supply of pragmatic problem solvers. Only to it's preening ideologues.

There are so many issues and operations involved that no one can - or needs to - understand all of them. All we have to do is be willing to be pragmatic instead of ideological.

If none of us can be as smart as all of us, then for heaven's sake, just leverage all of us? This can be as easy as we choose to make it.

Our greatest need is to get the ideologues off the stage sooner, and get back to simply using ourselves? One tombstone at a time is obviously not enough. Not anywhere near!

Systemic change in personnel requires changing fundamental methods fast enough, which requires bringing in new personnel. It's circular. It doesn't matter where in the cycle change is initiated. Once the cycle is interrupted, it'll fix itself. What we need are more frequent upgrades, just as Tom Jefferson advised, over 200 years ago. So HOW do we DO this? To discover how, we need to get far more minds involved, from all disciplines, across all 50 states.

There is always a way. Yet everyone is discussing every possible detail, instead of focussing on finding a way to just bring more people to a Democracy fight.

BYOD? Bring yer own Democracy?

You don't bring preening plutocrats to a democracy fight. It just don't work.

1923 & 1970 - "The scientific [currency] system for the automation age of abundance"

Commentary by Roger Erickson

SOCIAL CREDIT

Pay labor enough, so that it can consume everything that it is able to produce?

What a common sense premise! No wonder Control Frauds worked so hard to bury the suggestion. For passive parasites, the alternative is letting the Middle Class leverage all capabilities for exploring emerging options ... and thereby optimizing Adaptive Rate.

Who wants that? :(

Winterspeak — Foie Gras Bubble

When you take out a loan, even if it is at a very low interest rate, even if people can claim it's a negative real rate, you are not getting more money. You're getting more levered, which is the opposite of getting more money. When the problem is an overlevered economy, the solution cannot be even more leverage, but that's the only lever (apologies) the Fed really has and the confusion between this sort of horizontal money and the vertical money provided by government fiscal policy continues to lie at the heart of our ongoing financial crises and the difficulty of traditional economics to apprehend what is going on.

Winterspeak
Foie Gras Bubble

Noah Smith — The hard-money people throw Gene Fama under the bus

I think where one does see evidence of prices higher than they would be otherwise is likely in equities were low borrowing rates decrease the cost of margin (leverage). Cost of margin is hugely influential in speculative markets.

Housing "bubble" reigniting? No way. Prices are still way down from their highs, a historically high percentage of purchases of existing residential RE are foreclosure or underwater related and for cash, with Wall Street and flippers big buyers in expectation of exceptional ROI on resale. Rent/purchase ratio is still reflecting the bursting of the bubble, and new housing is not exactly "on fire." There is not going to be another housing bubble in the US for years and there are still housing bubbles to pop abroad.


But it's good to see the inflationistas in retreat and throwing the EMH under the bus, too, in favor of financial instability. But is the Fed creating financial instability now? No way. The Fed is still fighting the consequences of financial instability and not all that successfully.

Noahpinion
The hard-money people throw Gene Fama under the bus

Noah Smith

Sell On News — Leverage versus debt

Capitalism, I suspect, is doing its best to follow communism into the grave yard. Its strength was that it was not an ideology, just a practice – markets, after all, have been around for thousands of years. But the capitalist ideology of “financial deregulation” whose fruits are now so evident, the worship of markets as the solution to everything, is threatening the system itself.

Macrobusiness
Leverage versus debt
Sell On News
(h/t Lambert Strether at Naked Capitalism)

Winterspeak — Ask a banker, and listen to what they say!

Nice post on Planet Money which actually gets many of the facts right! Unfortunately, they do not see how these facts actually pull together, and so do not quite capture the core insight into bank operations. But overall, it's a nice piece.

Winterspeak
Ask a banker, and listen to what they say!

Lars Syll — Leverage cycles (wonkish) [video]

John Geanakoplos has a great lecture at Yale University on why central banks should pay much more attention to leverage cycles.He is forcefully arguing that one of the missing ingredients in the macro models used by central banks today are endogenous default and endogenous lending terms distinct from the interest rate. Focussing to much on interest rates have made them unable to recognise that changes in the perception of potential defaults can have serious repercussions on economic activities. It has also made central banks unable to detect the financial bubbles and to a faulty understanding of the nature of debt and leverage. In short – central banks have to a large degree based their policies on the wrong models.

Lars P. Syll's Blog
Leverage cycles (wonkish) (video)
Lars P. Syll | Professor, Malmo University

FRBSF — Credit: A Starring Role in the Downturn

Conclusion 

Any forecast that assumes the recovery from the Great Recession will resemble previous post-World War II recoveries runs the risk of overstating future economic growth, lending activity, interest rates, investment, and inflation. The data suggest that, this time around, credit cannot be considered a secondary effect. The interaction between the financial system and the real economy remains a weak spot of modern macroeconomic modeling. A careful analysis of 14 advanced economies over 140 years—data that extend far beyond the narrow post-World War II experience of the United States—reveals that the role of credit is sometimes central to understanding the business cycle.

Read it at Federal Reserve Bank of San Francisco Economic Letter
Credit: A Starring Role in the Downturn
by Òscar Jordà | research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco.
(h/t Mark Thoma)

Wray — The Fetish for Liquidity (and Reform of the Financial System)

In his General Theory, J.M. Keynes argued that substandard growth, financial instability, and unemployment are caused by the fetish for liquidity. The desire for a liquid position is anti-social because there is no such thing as liquidity in the aggregate.

Read it at Economonitor | Great Leap Forward
The Fetish for Liquidity (and Reform of the Financial System)

by L. Randall Wray

Study confirms balance sheet recession

Our theory predicted that the decline in employment in tradable industries would be uniform across the country. In other words, when Californians reduce their spending on goods produced throughout the country, employment in tradable industries nationwide will decline. This, too, is exactly what we found.

Making the assumption that the effect of household debt on non-tradable employment within the county is similar to the effect on tradable employment on a national scale, we found that 65 percent of the jobs lost during the depths of the recession were directly related to weak household balance sheets and the associated decline in spending.

We would be happy to entertain other theories to account for the economy’s continued weakness. Any hypotheses, however, must also be able to explain the extremely strong relation between household debt, consumption and unemployment at the county level.

Read the whole post at Bloomberg

How Household Debt Contributes to Unemployment: Mian and Sufi

(h/t Calculated Risk)