Macroeconomics and Finance

The crisis has led to a new wave of interest in research that seeks to add financial realism to macroeconomic models: this WSJ article provides an interesting overview.

7 replies on “Macroeconomics and Finance”

It is a nice term, a ‘leveraged optimist’.

“Using large amounts of borrowed money, or leverage, these buyers push up prices to extreme levels. Because those prices are far above what would make sense for investors using less borrowed money, they violate the idea of efficient markets.”

Looking at the newspaper today, I spotted an article where Mr. O’Regan a past developer and pub empire owner noted how his lending institution suddenly turned upon him in late 2008. His relationship with that lending institution up until then had been very good, a fifteen long years worth of it. It struck me, how sudden the change happened. It occured when the lending institution, Anglo Irish bank tried to alter the terms for his loan to purchase an old gentleman’s club at St. Stephens green. Altered the terms of the loan so as to make it difficult for O’Reilly to make it work.

I think this is a great line.

“This idea had big implications for policy makers. For decades, they thought of interest rates as the most important indicator of supply and demand in credit markets, and the only variable they needed to adjust to achieve a desired economic result.”

I remember an boss I had in late 2008, had listened to the radio all morning. He burst into our drawing studio around midday proclaiming, more or less, all is now saved, we are saved, the ECB has floored interest rates to let the economy roar again.

I remember thinking to myself, what a clown.

On this point,

“”His work assumes that the leverage cycle is bad, but gives little guidance [about] to what extent regulators should control it,” says Markus Brunnermeier”

Doesn’t Alan Greenspan make the point in his autobiography, that it is difficult for central bankers to do much at all, in the workings of the real economy. When Greenspan tried to get involved during the technology bubble, he soon found out, it was best for him to stay well away.

The same thing is this sentence:

“To that end, he believes central bankers should collect and publish data on the amount of leverage in the system, and intervene if it gets out of line.”

Taking about financial economists and macroeconomists getting together. I wonder how it is going to happen. Perhaps the division between the two types of economists was counter productive from the beginning. But it will be interesting to see how the heck central bankers get involved to the extent suggested by this article.

Fed-speak and all of that.

“but it would also mean limiting investors’ ability to use leverage in exuberant times.”

A whole new way to take away the punch bowl? Alan Greenspan’s autobiography is like one big story from end to end, describing what he had to do with a single control lever or trottle pedal – interest rates.

Greenspan seemed to take pride in his success with that control mechanism in the 1990s. But maybe that sense of pride and early success only set him up for the fall later on.

“If we could manage these cycles better, I think we’d all be better off.”

I’ll say.

Looking at this quote again:

“Using large amounts of borrowed money, or leverage, these buyers push up prices to extreme levels. Because those prices are far above what would make sense for investors using less borrowed money, they violate the idea of efficient markets.”

Mr. Geanakoplos’s theory is nice, but limited I think, because it assumes only one player in the market – the leveraged optimist.

What is the leveraged optimist and some other kind of market player hammer each other in a bidding war? That would seem to describe the Irish situation more accurately to me. In Ireland, we might have gotten off light, if it had only been the leveraged optimist.

That is why I tried to develop the concept of the chimney stack effect, and the aging population/life long savers demographic model in Kevin O’Rourke’s recent blog entry: The benefits of financial globalization have been oversold.

It allows me to put another player in the market besides the leveraged optimist and allow them to hammer the living day lights out of one another.

Simply looking at the Irish residential market, it was too sets of players bidding against each other which set the market really ablaze.

On the one hand, older middle aged savers who were concerned about de-valuation of savings and wanting to place those savings into hard assets. They did not require any loans. Then you had ordinary home buyers, who had to compete for the same hard asset, the home.

The Irish banks were forced to create leverage, to compete with the depositor life long savers they were losing to the market for hard physical assets.

My understanding of the property market at the higher level, at the commercial property level, there is a cycle. Whereby higher yields in recessionary times, encourage institutional investors into property. But during the boom times, those same large investors sell off their property portfolio and bid on bonds and stocks in the markets instead. In other words, there is a natural cycle whereby builders acquire property during boom years and institutions sell out. Or visa versa in recession times.

At any one time, there is someone interested in the property. But these players in the market are not hitting off one another. Rather they support each other in crucial ways through the cycles.

What is different this time I guess, is the institutional investors are in trouble also, and the government is the only buyer left – i.e. NAMA.

I am not sure if I am surprised or unsurprised by what I would consider the notable absense of mention of Hyman Minsky in the article.

I was thinking about this a little bit again today. An aspect of the recent asset bubble in Ireland has escaped analysis a bit I think.

The fact is, there was a growing fear amongst the aging population in Ireland, that as the boom cycle progressed in Ireland, everything was becoming more and more expensive. There seemed to be no brakes on that at all. I am sure it appeared to many people as they reach their mature years in their 50’s or 60’s and moved towards the end of their working lives, they might not be able to afford their retirement. That is, even with a mortgage paid and a roof over their heads, they thought they may need some additional income on the side to support themselves.

I wonder how much of that fed into the asset bubble also in Ireland’s case. That is where older folk who could afford maybe to invest some savings into property, as a generator of rental income, were hoping to hedge against that risk – ever present in their minds – that they might find themselves becoming increasingly ‘poor’ in their old age.

I was looking at Roubini’s interview with Mark Little on prime time web site. Roubini is an economist I haven’t read much of in the past. But he did mention specifically the need for economies to become efficient and offer good service for less than we did in the past. Of course, that makes perfect sense. If we enter into another growth cycle in our Irish economy, we will no doubt run into that same problem as we did in the past, with an even larger older population the next time becoming anxious they might not make ends meet.

That was a very prevalent thing in the Celtic Tiger years, and amongst all of the analysis of builders and bankers, it is a crucial aspect which hasn’t received it’s due atttention.

In other words, there is domestic growth industry prospects in Ireland for finding ways to improve services at reduced price. This is where the really strong companies of the future will operate. They may be existing companies or new companies. I think the solution we tried in the Celtic Tiger was to import as much cheap labour as we could afford to, and hope that would sovle the problem of providing services cheaply.

Looking back now, one can see how ham-fisted a solution that really was. We are not like New York or London where we can absorb a huge in-migration of a workforce to solve labour problems. We need to find another way.

One more radical idea.

I don’t mean, to clog up this comment area with useless ramblings, but it might be worth noting something here. What about a very blunt instrument, in the Irish context. A way in which a central banker might intervene. I am still very dubious about even suggesting this.

To my knowledge this has never been discussed here at the Irish economy. Supposing the government had become a player in the home building market in Ireland? Suppose the Irish government had produced and released a certain amount of property at an ‘affordable’ price onto the Irish market?

I mean, during the building boom when circumstances were exceptional. There is no need in my mind for a government to launch itself into the construction industry in times of a recession. But it a real pity, the Irish government did not launch itself into the industry during the Celtic Tiger and deliberately sell at below market value. The same as we are determined to buy above market value right now.

The reason for doing that is simple. To ensure there was a ceiling placed on how high property prices could go. I mean, the government is engaged in a practice currently to fix a floor to how low prices can go. Why not have a ceiling aswell? Would that be perceived as being anti-market-forces etc?

I mean, the state property company could operate in parallel in the market. I happens with our airlines, our bus systems shortly. Why not property?

I have no problem with young people in Ireland earning huge money if they can at their jobs. Wonderful, if they can afford to buy penthouse apartments for over a million euro in the suburbs or Dublin 6 or whatever.

But I keep getting back to this article by John Fitzgearld.

For sure, when property prices increased, the construction industry raised the bar, by affording higher wages to workers and dragged a workforce away from other sectors of the economy. There is no doubt, that four hundred thousand direct and indirect workforce the construction industry put together for itself is now in dire straits.

Many of them sunk all kinds of money into making great businesses to serve the construction industry. I know some of the best contractors and sub-contractors in the economy myself personally. If something doesn’t change soon their lives will effectively be ruined. They made one very large bet in their lives on what they were sure was a sure bet. But it wasn’t.

I wonder, how an artificial ceiling on property prices have been such a bad thing. Maybe this is the kind of intervention a central banker couuld make. I don’t know. Maybe as we go forward, NAMA could look at this role it could play in the Irish economy, I don’t know. A force to stabilize prices right across the economy and try to launch us on a more sustainable growth path the next time.

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