This year's econ #Nobel Prize was awarded to three professors for their research on banks and financial crises.
What struck me is this: "The laureates’ insights have improved our ability to avoid both serious crises and expensive bailouts,"
Did it though? 🧵 👇
What struck me is this: "The laureates’ insights have improved our ability to avoid both serious crises and expensive bailouts,"
Did it though? 🧵 👇
1/
First of all, let me be clear that I do not express any doubts towards the academic contributions of profs. Bernanke, Diamond, or Dybvig.
I read Bernanke's pre-Fed work on the Great Depression & am familiar with their work.
In a purely academic sense - kudos to the winners!
First of all, let me be clear that I do not express any doubts towards the academic contributions of profs. Bernanke, Diamond, or Dybvig.
I read Bernanke's pre-Fed work on the Great Depression & am familiar with their work.
In a purely academic sense - kudos to the winners!
2/
It's the policy implications that I find problematic.
Three points to be made here:
1 - QE arguably made the system more vulnerable, not less.
2 - systemic risk was amplified, not reduced
3 - the bailouts *were* expensive (and politically driven)
It's the policy implications that I find problematic.
Three points to be made here:
1 - QE arguably made the system more vulnerable, not less.
2 - systemic risk was amplified, not reduced
3 - the bailouts *were* expensive (and politically driven)
3/
Lots have been said on QE - a policy enacted during Bernanke's Fed governorship - and how it generated the asset bubble of the prior decade.
Many are blaming it for inflation, but that's not what concerns me - it's the systemic instability it created that I think is issue #1
Lots have been said on QE - a policy enacted during Bernanke's Fed governorship - and how it generated the asset bubble of the prior decade.
Many are blaming it for inflation, but that's not what concerns me - it's the systemic instability it created that I think is issue #1
4/
How?
When CBs buy gov't bonds to control long term interest rates,
they create a dependency mechanism where financial markets start to become over-reliant on CBs to continue providing all this ample liquidity in order to sustain asset price bubbles.
How?
When CBs buy gov't bonds to control long term interest rates,
they create a dependency mechanism where financial markets start to become over-reliant on CBs to continue providing all this ample liquidity in order to sustain asset price bubbles.
5/
Take, for example, what happened with UK pension funds two weeks ago
BoE had to step in to avoid margin calls of pension funds who couldn't make collateral on their bond-tied derivatives due to rising UK bond (gilt) yields
Pension funds holding derivatives for leverage?
Take, for example, what happened with UK pension funds two weeks ago
BoE had to step in to avoid margin calls of pension funds who couldn't make collateral on their bond-tied derivatives due to rising UK bond (gilt) yields
Pension funds holding derivatives for leverage?
6/
Yep. Another consequence of QE (more or less)
And these derivative contracts require collateral (often in cash) if prices start moving against them (as with any leveraged instrument)
When gild yields started soaring, collateral was requested within a very narrow time frame..
Yep. Another consequence of QE (more or less)
And these derivative contracts require collateral (often in cash) if prices start moving against them (as with any leveraged instrument)
When gild yields started soaring, collateral was requested within a very narrow time frame..
7/ ...what is typically a few weeks was now requested within an hour
Funds that didn't have cash to make payments had to sell their bonds.
This ofc created a feedback loop:
Selling more bonds => bond price ↓ yields ↑ => more calls for collateral => selling more bonds => ...
Funds that didn't have cash to make payments had to sell their bonds.
This ofc created a feedback loop:
Selling more bonds => bond price ↓ yields ↑ => more calls for collateral => selling more bonds => ...
8/
So the BoE *had to* step in with 5bn GBP (+20bn pledge) to prevent margin calls
How? Buying gilts in order to ↑ price and ↓ yields.
A huge buyer obviously eased pressure on pension finds and calmed markets, effectively preventing another Lehman moment.
So the BoE *had to* step in with 5bn GBP (+20bn pledge) to prevent margin calls
How? Buying gilts in order to ↑ price and ↓ yields.
A huge buyer obviously eased pressure on pension finds and calmed markets, effectively preventing another Lehman moment.
9/
Basically, BoE reignited QE in the midst of trying to make good on their promise to roll back QE (the so-called "taper") in order to curb double-digit inflation.
Does that sound like a system more or less prone to systemic risk?
Basically, BoE reignited QE in the midst of trying to make good on their promise to roll back QE (the so-called "taper") in order to curb double-digit inflation.
Does that sound like a system more or less prone to systemic risk?
10/
Furthermore, the whole reason we're entering a recession right now is because all the major CBs - Fed, BoE, ECB, BoJ - are tightening and reversing QE
The effect this has on the economy is like taking drugs away from addicts.
It's necessary, but it hurts (allegedly).
Furthermore, the whole reason we're entering a recession right now is because all the major CBs - Fed, BoE, ECB, BoJ - are tightening and reversing QE
The effect this has on the economy is like taking drugs away from addicts.
It's necessary, but it hurts (allegedly).
11/
However, unlike the drugs analogy
as soon as the patient gets ill - as we've seen in the UK - QE is back on.
Not really the perfect prescription, is it?
However, unlike the drugs analogy
as soon as the patient gets ill - as we've seen in the UK - QE is back on.
Not really the perfect prescription, is it?
12/
But CBs literally have no choice.
Their response to the previous crisis made the system much more fragile and prone to systemic collapse.
It got hooked on cheap money.
This, imho, is *not* how we use our knowledge to prevent crisis. If anything it amplifies them.
But CBs literally have no choice.
Their response to the previous crisis made the system much more fragile and prone to systemic collapse.
It got hooked on cheap money.
This, imho, is *not* how we use our knowledge to prevent crisis. If anything it amplifies them.
13/
As for the price of bailouts, one of my PhD papers - published last year - deals with this issue 👇
One sentence summary? The better connected you were to your Congressmen, the better your bailout deal was.
Shocking, I know :)
As for the price of bailouts, one of my PhD papers - published last year - deals with this issue 👇
One sentence summary? The better connected you were to your Congressmen, the better your bailout deal was.
Shocking, I know :)
https://twitter.com/wolf_vukovic/status/1456718773898067972
14/ Anyway, given the CB policy errors we've witnessed over the past years,
and given the systemic fragility created by "unconventional" monetary policy that "fixed" the previous crisis,
perhaps it was too soon to award contributions in this field.
and given the systemic fragility created by "unconventional" monetary policy that "fixed" the previous crisis,
perhaps it was too soon to award contributions in this field.
15/
Finally, spare me the "it's not really a Nobel prize" BS
Last year's prize was a case in point:
Finally, spare me the "it's not really a Nobel prize" BS
Last year's prize was a case in point:
https://twitter.com/wolf_vukovic/status/1447672645382819840
As always, thanks for reading :)
Follow me for more econ & finance related topics, or join my course where I teach the pitfalls of modern macro:
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Follow me for more econ & finance related topics, or join my course where I teach the pitfalls of modern macro:
maven.com/vuk-vukovic/ma…
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