Roots of the Current Crisis and its...
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University of Osijek Dr. Robert Sonora (Sub-Prime) Crisis Scenarios Housing and Money Liquidity Currently The Macroeconomy Labor Market and Firm Behavior US City Differences Capital Controls, Deregulation, Integration Liberalization of Capital Markets History Croatia Roots of the Current Crisis and its Implications Dr. Robert Sonora Department of Economics School of Business Administration Fort Lewis College Presented at the University of Osijek June 23, 2009
Transcript of Roots of the Current Crisis and its...
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Roots of the Current Crisis and itsImplications
Dr. Robert Sonora
Department of EconomicsSchool of Business Administration
Fort Lewis College
Presented at the University of Osijek
June 23, 2009
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Overview
1 (Sub-Prime) CrisisScenariosHousing and MoneyLiquidity
2 CurrentlyThe MacroeconomyLabor Market and Firm Behavior
3 US City Differences
4 Capital Controls, Deregulation, IntegrationLiberalization of Capital MarketsHistoryCroatia
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Scenario One
Consider . . .
Commercial real estate boom
Banking deregulation – risky assets and loans
Asset bubble
Lend “long”– borrow “short”
Inflation ↑⇒short term interest rates↑
Inept banking supervision (regulators ↓)
Forbearance: keep insolvent banks open
Central bank gave money to banks
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Scenario 2
or . . .
Deregulation⇒Risky loans ↑Asset bubble
Real estate bubble
Bank capital ↓deposits ↓defaults ↑⇒lending ↓Forbearance: keep insolvent banks open – assets “↑”Central bank gave money to banks
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run
Scenario One US 1989-90 S&L CrisisRecessionResolution Trust Corporation : $124b taxpayermoney≈ 750 failures
Scenario 2 Japanese Financial Crisis: 1995 – 2005-ishTen year recession – RGDP ↑0.9% anddeflationJapan $440b in taxpayer moneyGreater banking regulationsbut Uonly currency to appreciate against thedollar recently
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run
Scenario One US 1989-90 S&L CrisisRecessionResolution Trust Corporation : $124b taxpayermoney≈ 750 failures
Scenario 2 Japanese Financial Crisis: 1995 – 2005-ishTen year recession – RGDP ↑0.9% anddeflationJapan $440b in taxpayer moneyGreater banking regulationsbut Uonly currency to appreciate against thedollar recently
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Housing Market
GS1 = One Year Yield, FEDFUNDS = FFR, MORTG = 30 Year Fixed Mortgage, HOUST(R) = Housing Starts
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
State Housing Price: Bubble?
FLSTHPI = Florida, CASTHPI = California, COSTHPI = Colorado, MISTHPI=Michigan
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Mortgages and Foreclosure
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Excess Reserves and Non-Performing Loans
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run
This is what will concern us over the next 12-24 months
Output Gap, Unemployment, Inflation (Deflation?)
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Output Gap
The “Output Gap”
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Inflation and Unemployment
CPIAUCNS = Inflation, UNRATE = Unemployment Rate
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior
Home equity prices ↑
Credit Card ↑Borrowing ↑Household spending ↑
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior
Home equity prices ↑Credit Card ↑
Borrowing ↑Household spending ↑
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior
Home equity prices ↑Credit Card ↑Borrowing ↑
Household spending ↑
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior
Home equity prices ↑Credit Card ↑Borrowing ↑Household spending ↑
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior – Debt
TDSP(L) = Household Debt Service Payments as a Percent of Disposable Personal Income, DSPI(R) =
Disposable Personal Income, CMDEBT(R) = Household Sector: Liabilites
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior – Consumption
Consumption – Disposable Income Ratio (and 12 mo. MA)
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Consumer Behavior and RetailSales
University of Michigan Index of Consumer Sentiment and Retail Sales
UMCSENT = Consumer Sentiment, RRSFS(r) = Retail Sales
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Food Stamps
Food stamp claims and percent change to July 2009
Date 7/2003 7/2007 6/2008 7/2008 7/2009†Number Claims (mil) 22.0 26.6 28.7 29.1 33.5Population (mil) 290.1 302.0 304.6 304.9 305.1Percent Population 7.58% 8.81% 9.41% 9.53% 10.98%Percent Change 31.82% 9.10% 1.30% – 16.7%Annual Average 6.36% – – 1.30%
†Estimated
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Jobs Gain/Loss
PAYEMS(L) = Change Nonfarm Payrolls, OUTNFB(R), % Change Output Nonfarm Business Sector
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Firm Behavior – Industrial Production, Productivity,
Labor Participation
Industrial Production & Manufacturing Productivity: Annual % Change
OPHMFG(R) = Manufacturing Output per Hour, INDPRO(L) = Industrial Production, CIVPART = Labor
Participation Rate
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Short Run: Rest of the World
Figure: World GDP Growth: EZ, UK, Mexico, Canada, Japan, Australia
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Inflation
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Unemployment
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Composition
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Two questions:
With variety of differences across cities, how do wedesign domestic economic policy?
What about across countries?
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Two questions:
With variety of differences across cities, how do wedesign domestic economic policy?
What about across countries?
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Two questions:
With variety of differences across cities, how do wedesign domestic economic policy?
What about across countries?
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Capital Markets
Allows for free(r) movement of paper and realassets across borders
The less “advertised” part of Globalization
Not to be confused with free trade: tariffs↓, subsidies↓,“non-tariff” barriers↓Prerequisite for entry into many global economicentities: EU, NAFTA, WTO, etc.
Often accompanied by a fixed or “managed float”exchange rate regime⇒inflation stabilization
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Capital Markets: Benefits
Access to financial markets – loans, grants – to beused for creation of real (productive) capital
Access to foreign investors
Domestic access to foreign capital markets
Lower domestic interest rates
Economic stabilization: exchange rates, etc.
Gains in foreign currency reserves
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Capital Markets: Costs
May require painful economic reforms
Extraction of ‘rents’ by . . .
Economic de-stabilization: inflation?
Rapid ‘devestment’ of foreign and domesticholdings of domestic assets: currency crisis and/orcontagion⇒loss of confidence and economycollapses
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Deregulation
Reduces restrictions in domestic financial markets
Increases competition/innovation in financial markets⇒lower interest rates
May increase risk
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Integration
US and EZ
US: Identical Monetary policy, centralized fiscal policy
EZ: Identical Monetary policy, de-centralized fiscalpolicyCountries, different . . .
economic policyriskrates“objective” or “loss functions”Single EZ fiscal authority?
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Integration
US and EZ
US: Identical Monetary policy, centralized fiscal policy
EZ: Identical Monetary policy, de-centralized fiscalpolicyCountries, different . . .
economic policyriskrates“objective” or “loss functions”Single EZ fiscal authority?
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
UK: German Re-Unification
UK Bank Lending Rate and $/£
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Sweden: German Re-Unification
Swedish Overnight Interest Rates
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Mexican Peso Crisis
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
SE Asian Crisis
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Capital Markets: Croatian Precaution
Desire to join EZ
Price stability: managed float exchange rate⇒requiresforeign currency reserves
Removal of many capital restrictions & financialderegulation
Wary of currency crisis
Restrictions on foreign currency holdings: 51% of allforeign currency inflows held in Central Bank Vault⇒protect kuna
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
Capital Markets: Croatian Precaution
Currently: under pressure, difficult to get foreign loans,foreign currency reserves running low (out?), IMF loansto Eastern Europe
What if can’t repay foreign loans? Foreign Debt - GDPratio about 90%
Implications outside of Croatia: Italian, Austrian Banks(Swedish banks in the Baltic countries): Too big to failor too small to care?
House of cards
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
However
Some lessons may have been learned
In Croatia, the “51% rule”
In international community: less taste for financialcollapse (again) – economic and geo-political factors
On the other hand . . .
Last year’s oil price jump⇒global commodityprices↑⇒though short term, exacerbated current crisis
University ofOsijek
Dr. RobertSonora
(Sub-Prime)CrisisScenarios
Housing and Money
Liquidity
CurrentlyThe Macroeconomy
Labor Market andFirm Behavior
US CityDifferences
CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets
History
Croatia
However
Some lessons may have been learned
In Croatia, the “51% rule”
In international community: less taste for financialcollapse (again) – economic and geo-political factors
On the other hand . . .
Last year’s oil price jump⇒global commodityprices↑⇒though short term, exacerbated current crisis
