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Free Ebook The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster

Submitted by antoq on Tue, 11/04/2008 - 00:58

Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid- January did not justify, by itself, such a radical inter- eeting emergency Fed action followed by another cut at the formal FOMC meeting.

To understand the Fed actions one has to realize that there is now a rising probability of a
“catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.

That is the reason the Fed had thrown all caution to the wind – after a year in which it was behind the curve and underplaying the economic and financial risks – and has taken a very aggressive approach to risk management; this is a much more aggressive approach than the Greenspan one in spite of the initial views that the Bernanke Fed would be more cautious than Greenspan in reacting to economic and financial vulnerabilities.

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Ebook Credit Market Competition and Capital Regulation

Submitted by puput on Tue, 12/15/2009 - 03:18

A common justification for capital regulation for banks is the reduction of bank moral hazard. Given the presence of deposit insurance, banks have easy access to deposit funds. If they hold a low level of capital, there is an incentive for them to take on excessive risk. If the risky investment pays off, the banks’ shareholders receive the payoff. On the other hand, if it does not, the bulk of the losses are borne either by depositors or by the body providing deposit insurance. Given the widely accepted view that equity capital is more costly for banks than other forms of funds, the common assumption in much of the extant analyses of bank regulation is that capital adequacy standards should be binding as banks attempt to economize on the use of this costly input.

In practice, however, it appears that the amount of capital held by banks has varied substantially over time in a way that is difficult to explain as a function of regulatory changes. For example, Berger et al. (1995) report that in the 1840’s and 1850’s banks in the U.S. had capital ratios of around 40 to 50 percent. These ratios fell dramatically throughout the twentieth century, reaching a range of 6 to 8 percent in the 1940’s where they stayed until the end of the 1980’s. More recent evidence in Flannery and Rangan (2004) suggests that bank capital ratios have again increased, with banks in the U.S. now holding capital that is 75% in excess of the regulatory minimum (see also Barth et al., 2005, for international evidence). Given that capital adequacy standards were not in existence during much of the nineteenth century, and have not fluctuated much since their inception, it is hard to find a regulatory rationale to explain movements in banks’ capital holdings.

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Ebook Household Borrowing after Personal Bankruptcy

Submitted by wulan on Tue, 09/15/2009 - 04:18

A cornerstone of the U.S. consumer credit markets is the personal bankruptcy law, which aims to provide a “fresh start” to distressed debtors through debt discharge. Amid the fast growth of consumer credit in the past two decades, the number of households that have sought bankruptcy protection has also increased dramatically in the United States, with the annual rate of personal bankruptcy filings rising from 3.6 filings per thousand households in 1980 to nearly 14 in 2004. Such a rapid rise has motivated an extensive literature searching for the causes of personal bankruptcy filing. Most of the existing literature, however, focuses squarely on the prepetition conditions and financial market evolutions and pays little attention to household financial conditions post bankruptcy. This is somewhat surprising because what happens to postbankruptcy borrowing should affect the filing decision in the first place. In addition, studying postbankruptcy financial well being is critical to evaluating the effectiveness of the law. Moreover, with little empirical evidence documented as guidance, the existing dynamic equilibrium models with bankruptcy features may not have been realistically calibrated.

In this paper, we seek to address this void by providing a comprehensive analysis on house hold borrowing after personal bankruptcy filing. Using data from the Survey of Consumer Finances (SCF), we examine the differences in the use of credit between those households who have ever filed for bankruptcy and those who have never filed, hereafter “filers” and “nonfilers”, respectively. In addition, we study how the effects of bankruptcy filing vary with time passed since the last filing, hereafter “time since filing”. Specifically, for each of the three major debt categories credit card debt, first lien home mortgages, and vehicle loans we try to answer the following questions: Is it less likely for filers to take on such debt than comparable nonfilers? Conditional on having the access, do filers borrow less or pay a higher interest rate? Are filers more likely to experience renewed debt payment difficulties? How do these effects change with the staleness and the removal of a bankruptcy record from credit reports?

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