Raghuram G. Rajan: "Do All Loans Have a ‘Pound of Flesh’ Clause?"

In addition to having run the Reserve Bank of India, knowing much about American farmland in the 1920's and a fine veg cutlet, he also has a comfy endowed chair at the University of Chicago's Booth School of Business.

Here, via the Chicago Booth Review he talks debt, August 27. His interlocutor, Hal Weitzman, is an Adjunct Associate Professor of Behavioral Science and executive director for intellectual capital at Chicago Booth (oh, and also editor-in-chief of the CBR and host of The Chicago Booth Review podcast):

Almost all companies take loans—some secured by assets they own, and others unsecured. But is that distinction meaningful in the real world? Chicago Booth’s Raghuram G. Rajan talks about his research into corporate debt. In the past century, the amount of unsecured debt has soared. What’s the significance of that, and is it really unsecured? 

Audio Transcript 

Raghuram Rajan: So asset values matter. It's just that they're in the background. So if you have a boom and bust, even in a developed country, you will have fluctuations in your ability to borrow and you'll have really bad consequences if you've over-borrowed and asset values plummet.

Hal Weitzman: Almost all companies borrow money. Some of it's secured by assets they own, other debts, unsecured. But is that distinction meaningful in the real world? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman, and today I'm talking with Chicago Booth's Raghuram Rajan about his research into corporate debt. In the past century, the amount of unsecured debt has soared. What's the significance of that and is it really unsecured? Welcome to the Chicago Booth Review Podcast.

Raghuram Rajan: Thanks for having me.

Hal Weitzman: We're here to talk about your research on debt and all companies have debt, and broadly there are two kinds of debt, right? There's secured debt and there's unsecured debt. What's the difference? Remind us between the two.

Raghuram Rajan: Secured debt is when I attach an asset to the debt and say, "If I default on my debt, you can take the asset." So for example, when you lease a car, basically the debt is secured by the car and if you stop car payments, somebody comes and takes your car away. Similarly, for firms, a lot of secured debt against property plant and equipment, you have debt against receivables. So that's secured debt. Unsecured debt is when you have an obligation to pay, but there's no asset that the lender can seize. Of course, essentially all debt is against all assets. So while there's no specific asset they can seize if you don't pay, they basically can put you in bankruptcy, in which case the assets are really moved over to the creditor.

Hal Weitzman: Okay. And so that's kind of the conceit of this research, is that even unsecured debt is somehow secured. It's implicitly asset-backed.

Raghuram Rajan: Exactly.

Hal Weitzman: So if as you say, the reality is even if you have unsecured debt, at some point I'll be able to claim something back, does that mean there's not much of a difference practically between secured debt and unsecured debt?

Raghuram Rajan: Well, there is in the sense that if I secure my debt today, it gives me less flexibility. Obviously, I can't use the same asset to get more borrowing from somebody else down the line because I've already pledged it to somebody. So it gives me less financial flexibility. It may also give me less real flexibility in the sense that sometimes in the course of business, I want to sell this asset, I don't need it as much, but if it's pledged to a lender, I have to get their permission. Can I substitute this other asset? So it complicates matters.

It complicates the running of your business. It gives you less flexibility. It may also subject you to hold up if your lender basically said, "No, I want no other asset." Then you're stuck with this asset because you've already pledged it and you can't substitute it with something else. So if firms had a choice, they would prefer unsecured debt rather than secured debt as a form of issuance.

Hal Weitzman: Right. And so for those who are not in this world, that begs the question, why can't they get it? Is it just because people don't want to lend against not implicit assets rather than explicit ones?

Raghuram Rajan: Exactly. I mean, go back to Merchant of Venice.

Hal Weitzman: Sure....

....MUCH MORE 

Previous visits with Professor Rajan:

Raghuram Rajan: "We Should Be on the Alert for More Problems"

As noted in March 30 [2023's] "Raghuram G. Rajan: 'The Fed’s Role in the Bank Failures'"

Professor Rajan is one of the few central bankers who seems to know what's what (except maybe for the RBI currency switcheroo of November 2016. That was a fustercluck)....

Long time readers may remember Professor Rajan from such hits as: 

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet 

Okay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.

Also:

• Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
• Raghuram Rajan: "Disruption, Concentration, and the New Economy"
• "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
• Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE) 
• Former RBI Governor Raghuram G. Rajan On Development Economics: India Has An Opportunity To Do Something Never Before Attempted
•  Raghuram Rajan: "Breaking the Mould: Reimagining India’s Economic Future"
•  Raghuram G. Rajan: "Central Bank's Independence At Risk Of Being Dominated By Financial Assets"

Raghuram G. Rajan: "The Case for and against Central Bankers"

From the former head of the Reserve Bank of India via the University of Chicago, Booth School of Business (where he has a comfy endowed chair) Chicago Booth Review, November 16: 

Monetary policy makers set the stage for inflation but were slow to respond when it appeared.

Hindsight is, of course, 20/20. The pandemic was unprecedented and its consequences for the globalized economy very hard to predict. The fiscal response, perhaps much more generous because polarized legislatures could not agree on whom to exclude, was not easy to forecast. Few thought Vladimir Putin would go to war in February 2022, disrupting supply chains further and sending energy and food prices skyrocketing.

Undoubtedly, central bankers were slow to react to growing signs of inflation. In part, they believed they were still in the post-2008 financial crisis regime, when every price spike, even of oil, barely affected the overall price level. In an attempt to boost excessively low inflation, the US Fed even changed its framework during the pandemic, announcing it would be less reactive to anticipated inflation and would keep policies more accommodative for longer. This framework was appropriate for an era of structurally low demand and weak inflation but exactly the wrong one to espouse just as inflation was about to take off and every price increase fueled another. But who knew the times were a-changing?

Even with perfect foresight—and in reality, they are no better informed than capable market players—central bankers may still have been understandably behind the curve. A central bank cools inflation by slowing economic growth. Its policies have to be seen as reasonable or else it loses its independence. With governments having spent trillions to support their economies, employment just recovered from terrible lows, and inflation barely noticeable for over a decade, only a foolhardy central banker would have raised rates to disrupt growth if the public did not yet see inflation as a danger. Put differently, preemptive rate rises that slowed growth would have lacked public legitimacy—especially if they were successful and inflation did not rise subsequently. Central banks needed the public to see higher inflation to be able to take strong measures against it.

In sum, central bank hands were tied in different ways—by recent history and their beliefs, by the frameworks they had adopted to combat low inflation, and by the politics of the moment, with each of these factors influencing the others.

Yet stopping the postmortem at this point is probably overly generous to central banks. After all, their past actions reduced their room to maneuver and not just for the reasons just outlined. In particular, take the emergence of both fiscal dominance (whereby the central bank acts to accommodate the government’s fiscal spending) and financial dominance (where the central bank acquiesces to the imperatives of the market). They clearly are not unrelated to central bank actions of the past few years.

Long periods of low interest rates and high liquidity prompt an increase in asset prices and associated leveraging. And both the government and the private sector levered up. Of course, the pandemic and Putin’s war pushed up government spending. But so did ultra-low long-term interest rates and a bond market anesthetized by central bank actions such as quantitative easing. Indeed, there was a case for targeted government spending financed by long-term debt issues. Yet sensible economists making the case for spending did not caveat their recommendations enough, and fractured politics ensured that the only spending that could be legislated had something for everyone. And, of course, politicians, as always, drew on unsound but convenient theories (think Modern Monetary Theory) that gave them the license for unbridled spending.

While central banks can make the case that they were surprised by recent events, 

they played a role in constraining their own policy space. 

Central banks compounded the problem by buying government debt financed by overnight reserves, thus shortening the maturity of the financing of the consolidated balance sheet of the government and the central bank. This means that as interest rates rise, government finances, especially for slow-growing countries with significant debt, are likely to become more problematic....

....MUCH MORE 

 

I thought hindsight was 20/23 (or whatever the current year is) Anyhoo...

I am really coming around to the idea that both the inflation and the retarded reaction to it were deliberate. More on that another time. For now some previous visits with the good Professor:

 

May 25, 2023

Raghuram Rajan: "We Should Be on the Alert for More Problems"

As noted in March 30's "Raghuram G. Rajan: 'The Fed’s Role in the Bank Failures'"

Professor Rajan is one of the few central bankers who seems to know what's what (except maybe for the RBI currency switcheroo of November 2016. That was a fustercluck)....

February 11, 2022
Former Reserve Bank of India Head, Raghuram Rajan: "Central Banks Have to Start to Move"

«We sort of stopped thinking about countries like Italy. But if we come out of the pandemic and interest rates are not at 1% or 2%, but at 4% or 5%, what happens to public finances? Obviously, the biggest risks are always the ones you don’t see. But this is a risk we haven’t paid attention to for a long time»:

—Raghuram Rajan.

Long time readers may remember Professor Rajan from such hits as: 

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet 

Okay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.

Also:

• Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
• Raghuram Rajan: "Disruption, Concentration, and the New Economy"
• "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
• Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)

Raghuram Rajan: "We Should Be on the Alert for More Problems"

As noted in March 30's "Raghuram G. Rajan: 'The Fed’s Role in the Bank Failures'"

Professor Rajan is one of the few central bankers who seems to know what's what (except maybe for the RBI currency switcheroo of November 2016. That was a fustercluck)....

From Neue Zürcher Zeitung's TheMarket.ch, May 15:

Raghuram Rajan, Professor of Finance at the University of Chicago and former Governor of the Reserve Bank of India, fears that the crisis in the US banking sector is not over. He explains why he thinks the stress in the financial system is an unintended consequence of easy monetary policy, and why a soft landing seems unlikely.

Deutsche Version

In the United States, one bank after another is collapsing. After the failures of Silicon Valley Bank and Signature Bank in March, another bank, First Republic Bank, had to be rescued through an emergency takeover at the beginning of May. PacWest is feared to be next. Even the shares of larger banks such as US Bancorp and Capital One are under heavy pressure.

*****

Although things otherwise remain remarkably quiet in the financial markets, Raghuram Rajan sees no reason to sound the all-clear. «Unfortunately, the sense is that this particular phase of the banking problems is over, but I think the banking system still needs watching», says the finance professor at the University of Chicago and former Governor of the Reserve Bank of India.

Dr. Rajan knows what he is talking about. In the summer of 2005, he caused a stir when he warned against excesses in the banking system in front of the assembled financial elite at the economic symposium in Jackson Hole. He was sharply criticized back then, but today he is one of the most renowned economists of our time.

In an in-depth conversation with The Market NZZ, which has been lightly edited for length, he explains why the banking crisis is likely to continue, where the main vulnerabilities in the financial system are and why, in his view, they are a consequence of the easy money with which the Federal Reserve has repeatedly flooded the system in the past years. He also says why the risk of a hard landing for the economy is high.

«At some point, we need to pay more attention to easy monetary policy, creating the kind of financial vulnerabilities that lead to the problems we’re seeing today»: Raghuram Rajan.

Professor Rajan, the regional banking crisis in the US is dragging on. With First Republic Bank, another institution recently collapsed. How do you assess the situation?

As it was the case with Silicon Valley Bank and Signature Bank, First Republic Bank was in a very difficult situation. This was a bank in the category of the «walking wounded», it was inevitable that something would happen eventually. Unfortunately, the sense is that this particular phase of the banking problems is over, but I think the banking system still needs watching.

Why?

The recent events highlighted mid-sized banks with volatile deposits and asset problems. I think the asset problems haven’t gone away. There are still lots of losses to be absorbed on bank balance sheets, and the problem with volatile deposits hasn’t gone away either. There certainly are deposits that are looking at higher interest rates and demanding higher interest rates to stay. That means net interest margins for many banks are shrinking considerably. As a result, there will be an issue of longer-term health of the banking system, especially regarding mid-sized banks exposed to areas like commercial real estate....

....MUCH MORE

Some of our posts on Professor (U.Chicago-Booth) Rajan:

February 11, 2022
Former Reserve Bank of India Head, Raghuram Rajan: "Central Banks Have to Start to Move"

«We sort of stopped thinking about countries like Italy. But if we come out of the pandemic and interest rates are not at 1% or 2%, but at 4% or 5%, what happens to public finances? Obviously, the biggest risks are always the ones you don’t see. But this is a risk we haven’t paid attention to for a long time»:

—Raghuram Rajan.

Long time readers may remember Professor Rajan from such hits as: 

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet 

Okay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.

Also:

• Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
• Raghuram Rajan: "Disruption, Concentration, and the New Economy"
• "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
• Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)

Raghuram G. Rajan: "The Fed’s Role in the Bank Failures"

Professor Rajan is one of the few central bankers who seems to know what's what (except maybe for the RBI currency switcheroo of November 2016. That was a fustercluck).

I don't know his co-author (NYU-Stern) on this piece, from Project Syndicate, March 28:

There are four reasons to worry that the latest banking crisis could be systemic. For many years, periodic bouts of quantitative easing have expanded bank balance sheets and stuffed them with more uninsured deposits, making the banks increasingly vulnerable to changes in monetary policy and financial conditions. 

CHICAGO – The recent bank collapses in the United States seem to have an obvious cause. Ninety percent of the deposits at Silicon Valley Bank (SVB) and Signature Bank were uninsured, and uninsured deposits are understandably prone to runs. Moreover, both banks had invested significant sums in long-term bonds, the market value of which fell as interest rates rose. When SVB sold some of these bonds to raise funds, the unrealized losses embedded in its bond portfolio started coming to light. A failed equity offering then set off the run on deposits that sealed its fate.

But four elements of this simple explanation suggest that the problem may be more systemic. First, there is typically a huge increase in uninsured bank deposits whenever the US Federal Reserve engages in quantitative easing. Because it involves buying securities from the market in exchange for the central bank’s own liquid reserves (a form of cash), QE not only increases the size of the central-bank balance sheet, but also drives an expansion in the broader banking system’s balance sheet and its uninsured demandable deposits. 

We (along with co-authors) called attention to this under-appreciated fact in a paper presented at the Fed’s annual Jackson Hole conference in August 2022. As the Fed resumed QE during the pandemic, uninsured bank deposits rose from about $5.5 trillion at the end of 2019 to over $8 trillion by the first quarter of 2022. At SVB, deposit inflows increased from less than $5 billion in the third quarter of 2019 to an average of $14 billion per quarter during QE. But when the Fed ended QE, raised interest rates, and switched quickly to quantitative tightening (QT), these flows reversed. SVB started seeing an increase in outflows of uninsured deposits (some of which were coincident with the downturn in the tech sector, as the bank’s stressed clients started drawing down cash reserves).

Second, many banks, having benefited from the firehose of deposits, purchased liquid longer-term securities such as Treasury bonds and mortgage-backed securities, in order to generate a profitable “carry”: an interest-rate spread that provided yields above what the banks had to pay on deposits. Ordinarily, this would not be so risky. Long-term interest rates had not moved up much for a long time; and even if they did start to rise, bankers understand that depositors tend to be sleepy and will accept low deposit rates for a long time, even when market interest rates move up. The banks thus felt protected by both history and depositor complacency. 

Yet this time was different, because these were flighty uninsured deposits. Having been generated by Fed action, they were always poised to flow out when the Fed changed course. And because large depositors can coordinate easily among themselves, actions taken by just a few can trigger a cascade. Even at healthy banks, depositors who have woken up to bank risk and the healthier interest rates available at money-market funds will want to be compensated with higher interest rates. The juicy interest-rate spreads between investments and somnolent deposits will be threatened, impairing bank profitability and solvency. As an apt saying in the financial sector goes, “The road to hell is paved with positive carry.”....

....MUCH MORE

Some of our posts on Professor (U.Chicago-Booth) Rajan:

February 11, 2022
Former Reserve Bank of India Head, Raghuram Rajan: "Central Banks Have to Start to Move"

«We sort of stopped thinking about countries like Italy. But if we come out of the pandemic and interest rates are not at 1% or 2%, but at 4% or 5%, what happens to public finances? Obviously, the biggest risks are always the ones you don’t see. But this is a risk we haven’t paid attention to for a long time»:

—Raghuram Rajan.

Long time readers may remember Professor Rajan from such hits as: 

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet 

Okay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.

From Neue Zürcher Zeitung's TheMarket.ch, February 10:....

Also:

• Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
• Raghuram Rajan: "Disruption, Concentration, and the New Economy"
• "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
• Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)

Whoa!—Raghuram Rajan: "Where Has All the Liquidity Gone?"

When Professor Rajan was running the Reserve Bank of India he stood head-and-shouders above most all of the other Central Bankers of his cohort (except maybe for the RBI currency switcheroo of November 2016. That was a fustercluck)

From Project Syndicate, October 7:

Raghuram Rajan and Viral Acharya

After two years of quantitative easing, central banks have begun to shrink their balance sheets, and liquidity seems to have vanished in the space of just a few months – revealing acute financial-system vulnerabilities. It is now clear that monetary-policy normalization will be exceedingly difficult and fraught with risk.

CHICAGO/NEW YORK – The malfunctioning of the government bond market in a developed economy is an early warning of potential financial instability. In the United Kingdom, the new government’s proposed “mini-budget” raised the specter of unsustainable sovereign debt and led to a dramatic widening in long-term gilt yields. Recognizing the systemic importance of the government bond market, the Bank of England correctly stepped in, both pausing its plan to unload gilts from its balance sheet and announcing that it will buy gilts over a fortnight at a scale near that of its planned sales for the next 12 months. 

Markets have since calmed down. But as commendable as the BOE’s prompt response has been, we must ask what blame central banks bear for financial markets’ current fragility. After all, while long-term gilt yields have stabilized, gilt market liquidity (judging by bid-ask spreads) has not improved. And across the Atlantic, the market for US Treasuries is also raising liquidity concerns. Many metrics are flashing red, just like at the onset of the COVID-19 pandemic in 2020 and in the aftermath of Lehman Brothers’ failure in 2008. 

After two years of quantitative easing (QE) – when central banks buy long-term bonds from the private sector and issue liquid reserves in return – central banks around the world have begun to shrink their balance sheets, and liquidity seems to have vanished in the space of just a few months. Why has quantitative tightening (QT) produced that result? In a recent paper co-authored with Rahul Chauhan and Sascha Steffen (which we presented at the Federal Reserve Bank of Kansas City’s Jackson Hole conference in August), we show that QE may be quite difficult to reverse, because the financial sector has become dependent on easy liquidity. 

This dependency arises in multiple ways. Commercial banks, which typically hold the reserves supplied by central banks during QE, finance their own asset purchases with short-term demand deposits that represent potent claims on their liquidity in tough times. Moreover, although advanced-economy central-bank reserves are the safest assets on the planet, they offer low returns, so commercial banks have created additional revenue streams by offering reserve-backed liquidity insurance to others. This generally takes the form of higher credit card limits for households, contingent credit lines to asset managers and non-financial corporations, and broker-dealer relationships that promise to help speculators meet margin calls (demands for additional cash collateral).

The speculators are not limited to hedge funds, as we recently learned in the UK. Rather, they also include normally staid pension funds that have engaged in so-called liability-driven investment: To compensate for the QE-induced low return on long-term gilts, they increased the risk profile of their other assets, taking on more leverage, and hedging any interest risk with derivatives. 

While their hedged position ensured that an interest-rate increase would have an equal impact on their asset and liability values, it also generated margin calls on their derivative positions. Lacking the cash to meet these calls, they were reliant on bankers with spare liquidity for support. In sum, during periods of QE, the financial sector generates substantial potential claims on liquidity, effectively eating up much of the issued reserves. The quantity of spare liquidity is thus much smaller than that of issued reserves, which can become a big problem in the event of a shock, such as a government-induced scare.  

Our study also finds that, in the case of the United States, QT makes conditions even tighter still, because the financial sector does not quickly shrink the claims that it has issued on liquidity, even as the central bank takes back reserves. This, too, makes the system vulnerable to shocks – an accident waiting to happen. During the last episode of QT in the US, even relatively small, unexpected increases in liquidity demand – such as a surge in the Treasury’s account at the Fed – caused massive dislocation in Treasury repo markets. That is exactly what happened in September 2019, prompting the Fed to resume its liquidity injections...

....MUCH MORE

Also at Project Syndicate:

Germany’s Emerging War Economy

Some of our posts on Professor (U.Chicago/Booth) Rajan:

February 11, 2022
Former Reserve Bank of India Head, Raghuram Rajan: "Central Banks Have to Start to Move"
Long time readers may remember Professor Rajan from such hits as:

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet 

Okay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.

From Neue Zürcher Zeitung's TheMarket.ch, February 10:....

Also:

• Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
• Raghuram Rajan: "Disruption, Concentration, and the New Economy"
• "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
• Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)
  

And previously on our obsession with the events of September 2019:
"Economist Michael Hudson Says the Fed 'Broke the Law' with its Repo Loans to Wall Street Trading Houses"

A Nomura Document May Shed Light on the Repo Blowup and Fed Bailout of the Gang of Six in 2019 

"A Closer Look at the U.S. Bacon Situation"

 Money, Money, Money: "A Self-Fulfilling Prophecy: Systemic Collapse and Pandemic Simulation"

"The Day When Repo Rates Blew Out: Fed Recounts a Fiasco that Occurred as the FOMC Was Meeting, and How it Reacted

"The Federal Reserve's Explanation Of What Happened In The Money Markets In September 2019

For now this is just a personal bookmark but we may be referring back to it. What was going on in Q3 and Q4 2019 was a big enough deal that the Fed felt compelled to publish this little bit of narrative.

What seems to have happened was that somebody's derivative book got upside down to the tune of a few trillion dollars (notional, always say notional) and in addition the contagion through the counterparty daisy chain was also in the trillions and well, here's the Fed with their version.

From the Board of Governors of the Federal Reserve System....

....And more to come. We've been picking at this scab for quite a while and the picture puzzle  is only now coming together so dribs and drabs.

And how does this ancient history tie into what's going on in 2022?

Who knows? 

As noted in Saturday's "StockCats Asks For Clarification":

I have a feeling that lands somewhere in "the nebulous region between mere suspicion and probable cause"

 (LaFave & Israel on U.S. v. Ramsey, 431 U.S. 606 [1977])

that there is some sort of misdirection going on that I'm not understanding.

If so, any attempt at analysis of Fed policy and market moves by traditional means, global macro, central bank policy and practice, market internals such as options gamma etc., etc. is just so much blather.

And I keep coming back to the 3rd and 4th quarters of 2019 as the period when things were getting very weird.

More to come (maybe)

Trouble In Repo Land—The QE Endgame: A Big Problem Is Emerging For The Fed

Also "The Fed Is About to Ramp Up Balance-Sheet Shrinkage. It May Get Dicey". 

Former Reserve Bank of India Head, Raghuram Rajan: "Central Banks Have to Start to Move"

Long time readers may remember Professor Rajan from such hits as:

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet 

Okay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.

From Neue Zürcher Zeitung's TheMarket.ch, February 10:

Raghuram Rajan, Professor of Finance at the University of Chicago and former Governor of the Reserve Bank of India, believes the risk of persistently high inflation is significant. He warns that financial markets are underestimating the possibility of a substantial rise in interest rates.

Deutsche Version

The news is troubling: In the U.S., inflation rose further to 7.5% in January; again faster than expected and the highest level since the early 1980s. Bond market yields are rising, with interest rates on ten-year treasuries trading higher than pre-pandemic levels for the first time.

Despite these violent movements, equity markets remain surprisingly calm. The S&P 500 is barely more than 6% below its record high of early January – and that, in Raghuram Rajan’s view, is precisely the problem.

«Central banks have to switch to a different environment where they have to signal quite strongly that they mean business in going back to their old task which was containing inflation,» says the Professor of Finance at the University of Chicago and former Governor of the Reserve Bank of India. «Unfortunately, the perception that central banks are unwilling to do what it takes on the downside - not on the upside - makes this somewhat harder,» he adds.

Dr. Rajan knows what he is talking about. In the summer of 2005, he caused a stir when he warned against excesses in the banking system in front of the assembled financial elite at the economic symposium in Jackson Hole. He was sharply criticized back then, but today he is one of the most renowned economists of our time.

In an in-depth interview with The Market/NZZ, which has been lightly edited and condensed for clarity, he explains why he sees a real risk of persistently high inflation and what this could mean for financial markets. He also comments on China’s ambitious reform plans and on structural changes in the economy caused by the pandemic.

«We sort of stopped thinking about countries like Italy. But if we come out of the pandemic and interest rates are not at 1% or 2%, but at 4% or 5%, what happens to public finances? Obviously, the biggest risks are always the ones you don’t see. But this is a risk we haven’t paid attention to for a long time»:

—Raghuram Rajan.

Professor Rajan, in your latest essay for Project Syndicate you argue that we’re approaching «the end of free-lunch economics». What do you mean by that?

In developed countries, we’ve grown used to central banking as effectively having an unlimited capacity to do things that seem pleasant. In other words: We can keep interest rates really low which, of course, is not pleasant for the savers, but quite pleasant for borrowers and more generally for the economy. Meaning, we can buy assets and that increases asset prices. Typically, those who own assets enjoy that, whether it’s houses or financial assets. Overall, there has been very little constraint on the leeway to do more in terms of stimulative policies because of the low level of inflation....

....MUCH MORE

Some previous visits:

• Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
• Raghuram Rajan: "Disruption, Concentration, and the New Economy"
• "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
• Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE) 

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s

From the former head of the Reserve Bank of India, now hanging his hat at the University of Chicago's Booth School of Business (comfy endowed chair):

 

The Anatomy of a Credit Crisis: The Boom and Bust in Farm Land Prices in the United States in the 1920s (with Rodney Ramcharan), American Economic Review , April 2015

How important is the role of credit availability in inflating asset prices? And does greater credit availability make the economy more sensitive to changes in sentiment or fundamentals?  In this paper we address these questions by examining the rise (and fall) of farm land prices in the United States in the early twentieth century, attempting to identify the separate effects of changes in fundamentals and changes in the availability of credit on land prices. We find that credit availability likely had a direct effect on inflating land prices. Credit availability may have also amplified the relationship between the perceived improvement in fundamentals and land prices. When fundamentals turned down, however, areas with higher ex ante credit availability suffered a greater fall in land prices, and experienced higher bank failure rates. We draw lessons for regulatory policy.

*****

Does credit availability exacerbate asset price inflation? Are there long-run consequences? During the farm land price boom and bust before the Great Depression, we find that credit availability directly inflated land prices. Credit also amplified the relationship between positive fundamentals and land prices, leading to greater indebtedness. When fundamentals soured, areas with higher credit availability suffered a greater fall in land prices and had more bank failures. Land prices and credit availability also remained disproportionately low for decades in these areas, suggesting that leverage might render tem-porary credit-induced booms and busts persistent. We draw lessons for regulatory policy. (JEL E31, G21, G28, N22, N52, Q12, Q14 )

Asset price booms and busts often center around changes in credit availability (see, for example, the descriptions in Minsky 1986 and Kindleberger and Aliber 2005; theories such as Geanakoplos 2010; and the evidence in Borio and Lowe 2002, Mian and Sufi 2008, and Schularick and Taylor 2009). Some economists, however, claim that the availability of credit plays little role in asset price movements (e.g., see Glaeser, Gottlieb, and Gyourko 2010).

In this paper, we examine the boom (and bust) of farm land prices in the United States in the early twentieth century, using the variation in credit availability across counties in the United States to tease out the short- and long-run effects of the availability of credit on asset prices.The usual difficulty in drawing general lessons from episodes of booms and busts in different countries is that each crisis is sui generis, driven by differences in a broad range of hard-to-control-for factors.

The advantage of focusing on farm lending in the United States in the early twentieth century is that lending was local. So in effect, we have a large number of distinctive sub-economies, specifically, counties within each state, with some common (and thus constant) broad influences such as monetary policy and federal fiscal policy. Ceteris paribus, the more the banks in a county, the greater is the competition for depositor funds as well as the competition to offer credit, and closer is any bank to a potential customer, hence greater is the potential supply of intermediated funds. So our proxy for credit availability, through much of the paper, will be the log number of banks in a county. We rely on differences in bank regulations across states and Federal Reserve districts to allow us to isolate exogenous differences in credit availability.In addition, we have an exogenous boom and bust in agricultural commodity prices in the years 1917–1920, to which counties were differentially exposed.

The reasons for the commodity price rise are well documented. The emergence of the United States as an economic power helped foster a worldwide boom in commod-ities in the early twentieth century. The boom, especially in the prices of wheat and other grains, accelerated as World War I disrupted European agriculture, even while demand in the United States was strong. The Russian Revolution in 1917 fur-ther exacerbated the uncertainty about supply, and intensified the commodity price boom. However, European agricultural production resumed faster than expected after the war’s sudden end, and desperate for hard currency, the new Russian gov-ernment soon recommenced wheat and other commodity exports.

As a result, agricultural commodity prices plummeted starting in 1920 and declined through much of the 1920s (Yergin 1992; Blattman, Hwang, and Williamson 2007).1 Because different counties differed in the kind of crops they were most suited to produce, and each crop was affected to a different extent by the events in Europe, we have county by county variation in the perceived shock to fundamentals. Correcting for differences in the positive shock to fundamentals, we can tease out the effect of the availability of credit on land prices in 1920 (the peak of the boom).

We find that both fundamentals and credit availability mattered, but there was also a positive interaction effect; the shock generally boosted land prices even more in counties that had greater credit availability. We also explore the channels through which credit might have operated—whether it allowed marginal land to be brought into opera-tion, facilitated the more intensive use of existing land, allowed more investment in machinery, improved crop yields, or facilitated more leverage.

Credit availability seems to be primarily associated with higher leverage at the peak of the boom.The post-1920 collapse in commodity prices, induced by the resumption of European production, also allows us to examine the aftermath of the boom. Importantly, agricultural incomes fell, but only to levels before the acceleration in commodity price growth that started in 1917. This allows us to focus on the role of the financial leverage—both at the farm level and at the bank level—that built up in the boom years.

If the role of credit is relatively benign—borrowers simply sell the assets they had bought and repay credit—we should see relatively little independent effect of the prior availability of credit on asset prices, other than what rises the most falls the most. But if purchased assets are illiquid and hard to sell, and leverage cannot be brought down easily, we should see prices fall even more in areas that had easy access to credit. Also, distress, as evidenced in bank failures, should be more pronounced....

....MUCH MORE (39 page PDF)

 

Other visits with the former Reserve Bank of India honcho:
Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce":
Raghuram Rajan: "Disruption, Concentration, and the New Economy"
"World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet

FT Alphaville's Markets Live: The Great Financial Crisis, Day 1

Continuing our look at some of the more memorable sessions in Markets Live's storied history.
PM is Paul Murphy, NH is Neil Hume

Markets live transcript 8 Sep 2008

Live markets commentary from FT.com

11:00 am

PM Hi there

PM Welcome to Markets Suspended.

PM As you can image, Alphaville HQ has been a picture of tranquillity this morning.

11:01 am

PM The only noteworthy things that have happened is that the US treasury has launched the biggest bailout in history and the London Stock Exchange is broken.

PM Neil and I are keeping out heads down. And we think some of the readers should as well.

NH You know that there’s a real chance that someone has come on here during one of our regular glitches – and then they’ve gone and traded on the SETS order book or something – and they’ve infected the WHOLE London stock exchange system.

11:02 am

PM

NH

*LSE SAYS `CONNECTIVITY ISSUE' IS AFFECTING SOME CUSTOMERS

PM  http://tinyurl.com/6rrwpc

 

11:03 am

PM random pic for you

NH some questions below about this morning's outage

NH including will there be an auction to get things going again

 

11:03 am

NH and when will that be

NH we don't know

NH but the LSE has set up an incident website

 

11:04 am

PM  www.londonstockexchange.com/incident_website

NH which suggests things could be getting going soon

PM

connectivity will be enabled yet) All order book stocks have now been placed in a continuous auction phase and quote driven markets in a non mandatory period.

11:05 am

NH we are in an auction now

NH update on the incident site

NH Bryce has posted it below

 

11:06 am

NH FTSE 100 still being shown by the LSE as up 199.5 points at 5,440.2.

PM But you can use the City Index price to right here -- FTSE rooing bet quoted at 5492

PM that is effectively the Footsie future

 

11:06 am

PM

PM Anyway, along with the rest of the market we have thrown our tin hats into the air this morning.

PM Celebrating the smashing news that the US government has had to put $100bn a piece behind each of Fannie Mac and Freddie Mae.

 

11:07 am

NH It’s the other way around.

PM What do you mean? How could they put anything behind the government? They’re bust.

NH NO – its Fannie Mae and Freddie Mac.

 

11:08 am

PM Oh

PM Fecked and Fooked , for short.

NH Oooooooh. Nice one.

 

11:09 am

PM oh, i dont know actually

NH

NH going back to Fred and Fran

 

11:09 am

NH I think we should put up some research for the readers

NH who's done some good stuff??

PM I will start with Goldman Sachs

11:10 amPM

US Treasury places GSEs into conservatorship The US Treasury announced it has placed both Fannie Mae and Freddie Mac into conservatorship due to safety and soundness concerns. Specifically, the GSEs will suspend all dividends for existing common and preferred stock. The Treasury will also invest $1 billion upfront in senior preferred stock into each GSE with potentially further investments to cover future negative equity positions (from a GAAP standpoint). The Treasury has committed to covering negative equity positions with periodic senior preferred stock investments up to $100 billion per GSE. The senior preferred stock will be senior to all existing common and preferred stock, and carry a 10% coupon rate paid quarterly. In addition, the Treasury immediately receives warrants equivalent to a 79.9% ownership stake in each GSE going forward, and is entitled to a quarterly “fee” starting in 2010. The details regarding the fee are yet to be determined.....

And in a dandy little bit of ironic foreshadowing, considering what was to transpire one week later, they turn to another investment bank's thinking on Fannie and Freddie:

PM And Lehman

11:12 am

PM

Investment Conclusion The Treasury and FHFA have decided to put both GSEs into conservatorship. The action was taken "after examining all options available, and determining that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection". The Treasury will own 79.9% of the each company through new warrants, and will buy senior preferred stock as needed to maintain GAAP equity ratios. Our preliminary estimate of the dilution to equity holders is shown in Figure 1. We roughly estimate the warrants would reduce estimated year end 2008 core common book value per share from $19 to $4 per share at Fannie Mae, and from $21 to $6 per share at Freddie Mac. We still estimate the companies will return to profitability in 2010, but now estimate 2010 EPS of only $0.23 for FNM and $0.53 for FRE. To account for the substantial dilution and risk to future dilution from additional regulatory action, we are cutting our price-targets for both stocks to $4 and downgrading to our rating to 2-Equal weight....

....MUCH MORE

And more to come

Earlier:
FT Alphaville's Markets Live: The Great Financial Crisis, Day 0
FT Alphaville's Markets Live: The Fall Of Northern Rock
FT Alphaville's Markets Live: The Missing Early Transcripts

Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s

Attempting to get a handle on the possible trajectories for the current crises in farm country and also to fulfill a promise made last week* we have:
From Professor Rajan at the University of Chicago's Booth School of Business:

The Anatomy of a Credit Crisis: The Boom and Bust in Farm Land Prices in the United States in the 1920s (with Rodney Ramcharan), American Economic Review , April 2015

How important is the role of credit availability in inflating asset prices? And does greater credit availability make the economy more sensitive to changes in sentiment or fundamentals?  In this paper we address these questions by examining the rise (and fall) of farm land prices in the United States in the early twentieth century, attempting to identify the separate effects of changes in fundamentals and changes in the availability of credit on land prices. We find that credit availability likely had a direct effect on inflating land prices. Credit availability may have also amplified the relationship between the perceived improvement in fundamentals and land prices. When fundamentals turned down, however, areas with higher ex ante credit availability suffered a greater fall in land prices, and experienced higher bank failure rates. We draw lessons for regulatory policy.

*****

Does credit availability exacerbate asset price inflation? Are there long-run consequences? During the farm land price boom and bust before the Great Depression, we find that credit availability directly inflated land prices. Credit also amplified the relationship between positive fundamentals and land prices, leading to greater indebtedness. When fundamentals soured, areas with higher credit availability suffered a greater fall in land prices and had more bank failures. Land prices and credit availability also remained disproportionately low for decades in these areas, suggesting that leverage might render tem-porary credit-induced booms and busts persistent. We draw lessons for regulatory policy. (JEL E31, G21, G28, N22, N52, Q12, Q14 )

Asset price booms and busts often center around changes in credit availability (see, for example, the descriptions in Minsky 1986 and Kindleberger and Aliber 2005; theories such as Geanakoplos 2010; and the evidence in Borio and Lowe 2002, Mian and Sufi 2008, and Schularick and Taylor 2009). Some economists, however, claim that the availability of credit plays little role in asset price movements (e.g., see Glaeser, Gottlieb, and Gyourko 2010).

In this paper, we examine the boom (and bust) of farm land prices in the United States in the early twentieth century, using the variation in credit availability across counties in the United States to tease out the short- and long-run effects of the availability of credit on asset prices.The usual difficulty in drawing general lessons from episodes of booms and busts in different countries is that each crisis is sui generis, driven by differences in a broad range of hard-to-control-for factors.

The advantage of focusing on farm lending in the United States in the early twentieth century is that lending was local. So in effect, we have a large number of distinctive sub-economies, specifically, counties within each state, with some common (and thus constant) broad influences such as monetary policy and federal fiscal policy. Ceteris paribus, the more the banks in a county, the greater is the competition for depositor funds as well as the competition to offer credit, and closer is any bank to a potential customer, hence greater is the potential supply of intermediated funds. So our proxy for credit availability, through much of the paper, will be the log number of banks in a county. We rely on differences in bank regulations across states and Federal Reserve districts to allow us to isolate exogenous differences in credit availability.In addition, we have an exogenous boom and bust in agricultural commodity prices in the years 1917–1920, to which counties were differentially exposed.

The reasons for the commodity price rise are well documented. The emergence of the United States as an economic power helped foster a worldwide boom in commod-ities in the early twentieth century. The boom, especially in the prices of wheat and other grains, accelerated as World War I disrupted European agriculture, even while demand in the United States was strong. The Russian Revolution in 1917 fur-ther exacerbated the uncertainty about supply, and intensified the commodity price boom. However, European agricultural production resumed faster than expected after the war’s sudden end, and desperate for hard currency, the new Russian gov-ernment soon recommenced wheat and other commodity exports.

As a result, agricultural commodity prices plummeted starting in 1920 and declined through much of the 1920s (Yergin 1992; Blattman, Hwang, and Williamson 2007).1 Because different counties differed in the kind of crops they were most suited to produce, and each crop was affected to a different extent by the events in Europe, we have county by county variation in the perceived shock to fundamentals. Correcting for differences in the positive shock to fundamentals, we can tease out the effect of the availability of credit on land prices in 1920 (the peak of the boom).

We find that both fundamentals and credit availability mattered, but there was also a positive interaction effect; the shock generally boosted land prices even more in counties that had greater credit availability. We also explore the channels through which credit might have operated—whether it allowed marginal land to be brought into opera-tion, facilitated the more intensive use of existing land, allowed more investment in machinery, improved crop yields, or facilitated more leverage.

Credit availability seems to be primarily associated with higher leverage at the peak of the boom.The post-1920 collapse in commodity prices, induced by the resumption of European production, also allows us to examine the aftermath of the boom. Importantly, agricultural incomes fell, but only to levels before the acceleration in commodity price growth that started in 1917. This allows us to focus on the role of the financial leverage—both at the farm level and at the bank level—that built up in the boom years.

If the role of credit is relatively benign—borrowers simply sell the assets they had bought and repay credit—we should see relatively little independent effect of the prior availability of credit on asset prices, other than what rises the most falls the most. But if purchased assets are illiquid and hard to sell, and leverage cannot be brought down easily, we should see prices fall even more in areas that had easy access to credit. Also, distress, as evidenced in bank failures, should be more pronounced....

....MUCH MORE (39 page PDF)

*The outro from May 3's Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce":

...On another topic, the good Professor (and former RBI head) has written on the farm economy crisis of the 1920's that was the trial run for the Great Depression of a few years later. I've been meaning to link to one of his papers and with the currently unfolding rural econ disaster gaining momentum should probably get it on the blog sooner rather than later. Maybe this weekend.

Other visits with the former Reserve Bank of India honcho:
Raghuram Rajan: "Disruption, Concentration, and the New Economy"
"World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg Cutlet