Two positives for the recovery after the virus crisis abates will be a low oil price and low interest, two expansionary conditions. Supply shortages may temporarily put-up prices but deflation risks will increase if monetary policy will not contain second round effects./1
Stock prices will take care of themselves as the economy will recover. A big risk lies with high yield corporate bonds. Some defaults possible in the US. In general, corporate leverage has increased, sometimes to buyback own stocks, something liberalised in the US in 1982 /2
Also, in 1984 the US liberalised the issuance of mortgage ABS and later allowed them to be used in repos and changed the Bankruptcy Law to exclude repos from bankruptcy processes thus rendering them a “safe haven”, allowing an explosion of inside liquidity that funded bubbles./3
Many other steps were taken to liberalise the tiger of finance since the 1960s, e.g. Basel allowing the use of banks’ internal models for the assessment of market risk in the 90s or the unconditional repeal of Glass-Steagall in the US/4
Usual arguments against financial regulation rely on the notion that more finance is always good for growth. More recent evidence has shown that when it grows above a certain ratio of private credit to GDP(around 100% says BIS wp 381), finance stops helping economic growth /5
A reflection on the excesses of finance will again be warranted after the crisis abates. Is monetary policy condemned to financial market dominance and stock market FED-puts forever? Are these puts to the stock market really warranted? /6
Should the central banks’ mandate be extended to explicitly include financial stability, giving them more instruments to try to contain asset prices booms instead of just “mopping-up after the crash”. Policy reviews are ongoing and everything must be on the table this time. /end
