John Cochrane captures a great idea in the title of his post, Stopping Bank Crises Before They Start. It is not clear to me that he captures the same idea in the post itself.
On his sidebar, Cochrane links to Writing Tips for Ph.D. Students (PDF) where he says
A good joke or a mystery novel has a long windup to the final punchline. Don’t write papers like that — put the punchline right up front and then slowly explain the joke.
I suppose that's what he did in this Stopping Bank Crises post -- put the punchline up front where someone like me won't get it:
At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.
But I'm not convinced. Oh, I'm interested, interested enough to chase down a few stray thoughts by way of my own "long windup" here. But I'm not at all convinced that the financial crisis was a run.
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Oh -- maybe it became a run, but that's not the same thing.
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| Wikipedia |
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| Wikipedia |
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| Wikipedia |
Accompanying Wikipedia's Geithner note is the following graph:
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| Securitization markets were impaired during the crisis. |
Okay, so it was a run. I see it now. I'm convinced. The peak was in 2006. The draw-down after 2006 on the graph is the run.
Now... Cochrane again:
At its core, the recent financial crisis was a run...
The run made the crisis...
This is a vital and liberating insight: To stop future crises, the financial system needs to be reformed so that it is not prone to runs.
Well... if the "run" is the big drop since 2006 on the graph... then I don't think that's the part we should stop. I think we should stop the run-up that we see from 2000 to 2006 on the same graph. If we never had that run-up, we couldn't have had the run.
But I don't know if that's what Cochrane is saying, or not.
Big Numbers
Cochrane writes:
By the time they failed in 2008, Lehman Brothers and Bear Stearns were funding portfolios of mortgage-backed securities with overnight debt leveraged 30 to 1. For each $1 of equity capital, the banks borrowed $30. Then, every single day, they had to borrow 30 new dollars to pay off the previous day's loans.
Yeah. If Lehman was funding portfolios leveraged at 4 or 5 to 1, Lehman would still be in business today. The excessive buildup is the problem. Like I said about the graph.
I think I agree with John Cochrane on this... I agree with what I think he's saying.
3 comments:
Hi Art,
The collapse of private label mortgage backed securities was not the "run". That was what triggered the run.
The run was in money market funds.
Paul McCulley explains:
http://www.frbatlanta.org/news/multimedia/12fmc_mcculley_interview.cfm
What the Cochrane article failed to make clear was that the "run" was averted (stopped and reversed in its early stages). Had the run actually happened in full the financial losses would have been staggering beyond description.
Thanks, Jim. Makes sense when you say it.
Preparing for an economic crisis can really be stressful especially of our resources is limited. The best thing to do is to make use of whatever resources that we have to shield us from uncertainties brought about by an economic collapse.
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