Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Understanding the Financial Crisis Presentation to Students & Friends of Rensselaer Hartford Hartford, CT James Stodder, (Ph.D., Economics, Yale 1990) Lally School of Management & Technology Rensselaer Polytechnic Institute at Hartford Hartford, Connecticut, USA Outline of Talk 1. Keynes on Credit Cycles: - Why we need Regulation 2. Where is the Bottom? 3. Connecticut is Middle of the Pack 4. Government Deficit Spending a. Needed in the Short-term b. But a Big Problem Long-term Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 20162 (1) Biz & Credit Cycles J. M. Keynes: Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 20163 4 US Macro-Stability: Better, Room for Improvement Source:45%55% 66%34% Bad News: Bubbles are Endemic Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Arlington Williams, Price Bubbles Good News: People Do Learn Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, V. Smith & A. Williams, Experimental Market Economics, Scientific American, Dec. 92 The Wisdom of Keynes Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, A sound banker, alas, is not one who foresees danger and avoids A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way, along with his fellows, so that no one can really blame him. - J.M. Keynes (1931) it, but one who, when he is ruined, is ruined in a conventional way, along with his fellows, so that no one can really blame him. - J.M. Keynes (1931) Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Paradox of Thrift Keynes noted: Consumers cut back on their spending and save more during a recession. This only makes the recession worse. Similarly for Banks, Loan Loss Reserves (LLR) are often raised in a recession, just when households and businesses most need credit ensuring more collapses and worsening the recession. Insurance => Moral Hazard => Necessity of Regulation Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Moral Hazard of Insurance: If you had a car that is less damaged by any given car crash would that make you drive faster? If you had a car that is less damaged by any given car crash would that make you drive faster? If you (and everybody else) drove faster, could this actually wind up making you less safe ? If you (and everybody else) drove faster, could this actually wind up making you less safe ? Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Availability of Bank Loans Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Currency & Reserves Up 4x Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 But Bank Reserves up 100x Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 M0 = Currency + Bank Reserves $2.6t Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 M1 $1.9t = Currency + Bank Deposits Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 Money Mult. = M1/M0 1.9 / 2.6 = 0.73 Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 Bank Money Multiplier If l = % loans, Reserve multiplier is D = R(1+ l + l 2 + + l ) = R/(1- l ) If M0 = Currency (C) + Reserves (R), M1=Currency + Deposits, so: M1 = C + R/(1- l ) = M0R+ R/(1- l ) M1/M0 = 1+{-R + R/(1- l )}/M0 So M1/M0 l l < 0 Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, New Yorker, Oct Limits of Fed Magic The Zero Bound Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 The Zero Bound (2) Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 Quantity of Money Equation M*V P*Y Money * Velocity Price * Output => ln(M) + ln(V) = ln(P) + ln(Y) => i.e., % M + % V = % P + % Y over time Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 20-Feb-1622 % Money Turnover [ = % (Money x Velocity) ] is Too Pro-Cyclical because of Velocity % (M x V) % V % M Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Keyness Liquidity Trap: Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Keyness Liquidity Trap: Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Keyness Liquidity Trap: Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Keyness Liquidity Trap: Okuns Law Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Output Gap 20% GDPOutlook_Testimony.pdfOutlook_Testimony.pdfOutlook_Testimony.pdfOutlook_Testimony.pdf A little Stimulus Math: 20% * $14 tr. = $2.8 tr. Stim*1.5 = $2.8 => Stim = $1.87 tr. Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, (2) Bottom Still a Ways Off Okuns Law, and Slow Recovery Okuns Law, and Slow Recovery Housing Recovery probably still a year away. Housing Recovery probably still a year away. Credit Markets still very weak. Credit Markets still very weak. Stock Market Valuation Ratios like P/E and Tobins Q are now only at historical averages. Stock Market Valuation Ratios like P/E and Tobins Q are now only at historical averages. Unemployment Trend : Unemployment Trend :Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Housing Bottom A Long Way Off Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Why it Matters to Everyone TED-Spread & Financial Crises Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, S&L crisis Subprime financial shock Peso crisis LTCM Tech bust Orange County Thai baht Y2K 108 Years of P/E and Q Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Shiller/Smithers - Worst Post-War Unemployment Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, June 8, 2011 Long Unemployment Dip Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, (3) CT & NY in Middle of Pack Financial Sector down, but.. Financial Sector down, but.. Conventional Banking and Insurance less vulnerable than Investment Banks, Financial Insurance Conventional Banking and Insurance less vulnerable than Investment Banks, Financial Insurance Defense industries well insulated Defense industries well insulated Pharmaceuticals and Biotech have good long-term prospects Pharmaceuticals and Biotech have good long-term prospects House Price Increases near US Avg. House Price Increases near US Avg. Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, International Housing Prices Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Sun Belt, Rust Belt Concentration Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Peak of Price-to-Rent Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Source: NY Times, April 20, 2010 Housing Prices in Northeast Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Median Price, Existing Single-Family Homes, NY & CT ($1,000) (4) More Federal Deficit Spending (not Tax Cuts) Necessary Tax cuts to the rich more likely to be saved, not spent or invested. Tax cuts to the rich more likely to be saved, not spent or invested. Tax cuts dont have big effect on those too poor to pay many taxes. Tax cuts dont have big effect on those too poor to pay many taxes. Unmet needs in Energy, Environment, Health, and Education: good reasons to spend. Unmet needs in Energy, Environment, Health, and Education: good reasons to spend. Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Government Must Increase Spending in Severe Recession If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (Keynes, General Theory, 1937) Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, But We Need Foreign Coordination for US Expansion to be Successful Benefits of lone expansion leak out, other countries free ride. Benefits of lone expansion leak out, other countries free ride. Alternatives to joint expansion are protectionism and competitive devaluations. Alternatives to joint expansion are protectionism and competitive devaluations. US long-term Fiscal Gap makes lone expansion untenable. US long-term Fiscal Gap makes lone expansion untenable. Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Long Term Fiscal Gap: Unsustainable Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Sure as Debt and Taxes Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Inflation/Devaluation a Powerful Temptation for Highly Indebted Governments Germany after WWI Russia after the Revolution Soviet Union after the Cold War Many Developing Countries after spending, investment binges (See L. Kotlikoff & S. Burns, The Coming Generational Storm, 2004) Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Implications of Limited Pass-Through Linda Goldberg (FRBNY) has shown that Dollar Devaluation means: Improved Earnings on Foreign AssetsImproved Earnings on Foreign Assets Easier Debt ServicingEasier Debt Servicing Smaller Trade DeficitSmaller Trade Deficit And at the same time, Minimal Costs in further InflationMinimal Costs in further Inflation So - Whats Not to Like? FRBNY Governor Frederic Mishkin says Devaluation cannot be a policy. (I think he means an explicit policy.)FRBNY Governor Frederic Mishkin says Devaluation cannot be a policy. (I think he means an explicit policy.) Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Inflation/Devaluation Appears a Painless Way Out of Debt Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, Promising Investments? Medium-Term Holds (Very Cautious): US Treasuries (but not long term remember inflation) US Treasuries (but not long term remember inflation) Gold, Silver, other precious metals Gold, Silver, other precious metals Long-Term Holds (Patient): Non-Dollar Assets in Emerging Markets Non-Dollar Assets in Emerging Markets Renewable Energy Technology Renewable Energy Technology Pharmaceuticals: tied to incomes in emerging markets Pharmaceuticals: tied to incomes in emerging markets Summary of Conclusions Recession will be long and deep: housing slump, interbank lending, financial markets likely to overshoot on low side. Recession will be long and deep: housing slump, interbank lending, financial markets likely to overshoot on low side. CT, NY are middle of the pack for housing prices and employment stability. CT, NY are middle of the pack for housing prices and employment stability. Greatly expanded federal spending is needed in the short-term. Greatly expanded federal spending is needed in the short-term. Long-term, however, US government debt is unsustainable. Long-term, however, US government debt is unsustainable. There are still some places to put your money There are still some places to put your money Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20, 2016Saturday, February 20,