Academic Views of the Financial Mess
These have all been pieces written by economists for lay readers.
Here’s a sampling of what economists have been writing for each other lately — i.e., new working papers issued by the National Bureau of Economic Research — about different facets of the crisis:
Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special-purpose vehicles, and derivatives, all related to subprime mortgages.
I describe the relevant securities, derivatives, and vehicles to show: 1) how the chain of interlinked securities was sensitive to house prices; 2) how asymmetric information was created via complexity; 3) how the risk was spread in an opaque way; and 4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed.
These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.
Anil Kashyap of the University of Chicago, who has co-written two excellent guest posts on this blog, has co-authored a new working paper with Takeo Hoshi of the University of California, San Diego, called “Will the TARP Succeed? Lessons From Japan.” Its abstract:
The U.S. government is hiring asset managers to purchase up to $700 billion of toxic real estate securities that are the center of the current credit crisis. Buying up assets, if done properly, might address the collective under-capitalization that is the fundamental problem plaguing the financial system.
But, experience with financial crises in other countries suggests that success is by no means guaranteed. Japan was the largest other country where the banks were seriously undercapitalized, and where asset purchases were a critical part of the government’s response to the problem.
The U.S. bailout plan is similar to the Japanese approach in that it does not clearly identify the capital problem as critical, and instead proposes using AMC’s to remove distressed assets from bank balance sheets. When Japan used AMC’s, their effectiveness was limited in part because they did not purchase enough assets. AMC’s did not help recapitalization either, and Japan had to come up with different mechanisms to use public funds for recapitalization. Both these risks are also present for the U.S. plan.
And finally, Fernando Ferreira, Joseph Gyourko, and Joseph Tracy have written a paper with some surprising news about what happens after homeowners achieve negative equity in their houses. It’s called “Housing Busts and Household Mobility,” and here’s the abstract:
Using two decades of American Housing Survey data from 1985 to 2005, we estimate the impact on household mobility of owners having negative equity in their homes and of rising mortgage interest rates.
We find that both lead to lower, not higher, mobility rates over time. The impacts are economically large, with mobility being almost 50 percent lower for owners with negative equity in their homes.
This does not imply that current worries about defaults and owners having to move from their homes are entirely misplaced. It does indicate that, in the past, the lock-in effects of these two factors were dominant over time.
Our results cannot simply be extrapolated to the future, but policy makers should begin to consider the consequences of lock-in and reduced household mobility, because they are quite different from those associated with default and higher mobility.