Comments on: The first true twenty-first century financial crisis? http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/ Fri, 09 Jan 2009 00:56:33 +0000 http://wordpress.org/?v=2.6.1 By: RebelEconomist http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100161 RebelEconomist Fri, 21 Sep 2007 11:55:01 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100161 EthanJ: If only the answer was so easy to find! In order to consider the problem I refer to, you first have to appreciate its existence.....checkout NBER WP 7420. EthanJ:

If only the answer was so easy to find! In order to consider the problem I refer to, you first have to appreciate its existence…..checkout NBER WP 7420.

]]> By: EthanJ http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100160 EthanJ Fri, 21 Sep 2007 06:35:04 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100160 <i>how central banks manage to set interest rates (at least without taking a substantial amount of one side of the market) remains a mystery to me..."</i> Rebel Economist, you could do worse than start here: http://en.wikipedia.org/wiki/Federal_funds_rate how central banks manage to set interest rates (at least without taking a substantial amount of one side of the market) remains a mystery to me…”

Rebel Economist, you could do worse than start here: http://en.wikipedia.org/wiki/Federal_funds_rate

]]> By: Anonymous http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100159 Anonymous Thu, 20 Sep 2007 04:07:11 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100159 " Anonymous: Clever argument, but I think that this effect should be fairly minor. There is also the point that there will be a risk premium on the risk compensation itself, which will probably vary with the risk free rate. But I don't think this explains how central banks get away with what they do either. I have been thinking about this question for a while, and had a long discussion with jkh about it on a previous post. Ben Friedman's NBER working paper 7420 shows that even the experts are puzzled. As I say, how central banks manage to set interest rates (at least without taking a substantial amount of one side of the market) remains a mystery to me, but I just wonder whether it is one explanation for disintermediation from banks - ie the market finds a way of detaching itself from the unrealistic rate set by the central bank. Written by RebelEconomist on 2007-09-20 05:06:26 " Your second sentence is worthy of an award of some sort. Of course, the other obvious argument is that lower interest rates per se tend to reduce expected losses and credit risk at the macroeconomic level in a very general sense - and therefore tend to reduce risk premiums when the fed funds rate declines. Also, think of the difference between the fed funds rate and the risk free rate as the ‘senior tier' of risk in the financial markets. Treasury bill rates plummeted prior to the fed funds decrease. The fed move narrowed that spread - paving the way for the proportionate narrowing in more junior ‘tranche' spreads above fed funds. ” Anonymous:

Clever argument, but I think that this effect should be fairly minor. There is also the point that there will be a risk premium on the risk compensation itself, which will probably vary with the risk free rate. But I don’t think this explains how central banks get away with what they do either. I have been thinking about this question for a while, and had a long discussion with jkh about it on a previous post. Ben Friedman’s NBER working paper 7420 shows that even the experts are puzzled.

As I say, how central banks manage to set interest rates (at least without taking a substantial amount of one side of the market) remains a mystery to me, but I just wonder whether it is one explanation for disintermediation from banks - ie the market finds a way of detaching itself from the unrealistic rate set by the central bank.
Written by RebelEconomist on 2007-09-20 05:06:26 ”

Your second sentence is worthy of an award of some sort.

Of course, the other obvious argument is that lower interest rates per se tend to reduce expected losses and credit risk at the macroeconomic level in a very general sense - and therefore tend to reduce risk premiums when the fed funds rate declines.

Also, think of the difference between the fed funds rate and the risk free rate as the ‘senior tier’ of risk in the financial markets. Treasury bill rates plummeted prior to the fed funds decrease. The fed move narrowed that spread - paving the way for the proportionate narrowing in more junior ‘tranche’ spreads above fed funds.

]]> By: RebelEconomist http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100158 RebelEconomist Thu, 20 Sep 2007 01:06:26 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100158 Anonymous: Clever argument, but I think that this effect should be fairly minor. There is also the point that there will be a risk premium on the risk compensation itself, which will probably vary with the risk free rate. But I don't think this explains how central banks get away with what they do either. I have been thinking about this question for a while, and had a long discussion with jkh about it on a previous post. Ben Friedman's NBER working paper 7420 shows that even the experts are puzzled. As I say, how central banks manage to set interest rates (at least without taking a substantial amount of one side of the market) remains a mystery to me, but I just wonder whether it is one explanation for disintermediation from banks - ie the market finds a way of detaching itself from the unrealistic rate set by the central bank. Anonymous:

Clever argument, but I think that this effect should be fairly minor. There is also the point that there will be a risk premium on the risk compensation itself, which will probably vary with the risk free rate. But I don’t think this explains how central banks get away with what they do either. I have been thinking about this question for a while, and had a long discussion with jkh about it on a previous post. Ben Friedman’s NBER working paper 7420 shows that even the experts are puzzled.

As I say, how central banks manage to set interest rates (at least without taking a substantial amount of one side of the market) remains a mystery to me, but I just wonder whether it is one explanation for disintermediation from banks - ie the market finds a way of detaching itself from the unrealistic rate set by the central bank.

]]> By: Anonymous http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100157 Anonymous Wed, 19 Sep 2007 13:02:04 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100157 Although with lower rates, the present value of the risk compensation will exceed the present value of the risk, due to the interacting effect of serial flows and bond yield convexity. This would drive prices higher and risk spreads lower. Although with lower rates, the present value of the risk compensation will exceed the present value of the risk, due to the interacting effect of serial flows and bond yield convexity. This would drive prices higher and risk spreads lower.

]]> By: Anonymous http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100156 Anonymous Wed, 19 Sep 2007 12:53:31 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100156 " If the spread over the risk free rate is compensation for expected loss, there is no reason why it should be related to the risk free rate itself. This question is not so straightforward after all! Written by RebelEconomist on 2007-09-19 15:39:29 " Good point. I suspect there's a counter, but I can't summon it here. Cheers. ” If the spread over the risk free rate is compensation for expected loss, there is no reason why it should be related to the risk free rate itself.

This question is not so straightforward after all!

Written by RebelEconomist on 2007-09-19 15:39:29 ”

Good point.

I suspect there’s a counter, but I can’t summon it here.

Cheers.

]]> By: Guest http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100155 Guest Wed, 19 Sep 2007 12:25:58 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100155 Twofish: You have a person that just suffered a heart attack. Maybe a big reason was that he didn't get enough exercise, but that's hardly a reason to force him to run to the hospital. That all fine in theory but what happens if the patient insists on bingeing again and again and has to be brought to the ER more and more often, each time with a bigger problem and more expensive procedures? At what point do you lock the patient up in a rehab facility and keep him under adult supervision? Twofish: The first thing to do in a crisis is to stabilize the situation so that you have time to think. The scary thing about financial crises is that they often happen so quickly that you don't have time to think. Big words. The problem is someone forgot to tell Alan Greenspan to do the thinking part after the situation got stabilized in 2003-04. Why should we expect things to be different this time? Twofish: You have a person that just suffered a heart attack. Maybe a big reason was that he didn’t get enough exercise, but that’s hardly a reason to force him to run to the hospital.

That all fine in theory but what happens if the patient insists on bingeing again and again and has to be brought to the ER more and more often, each time with a bigger problem and more expensive procedures? At what point do you lock the patient up in a rehab facility and keep him under adult supervision?

Twofish: The first thing to do in a crisis is to stabilize the situation so that you have time to think. The scary thing about financial crises is that they often happen so quickly that you don’t have time to think.

Big words. The problem is someone forgot to tell Alan Greenspan to do the thinking part after the situation got stabilized in 2003-04. Why should we expect things to be different this time?

]]> By: Guest http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100154 Guest Wed, 19 Sep 2007 12:05:20 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100154 <i>Furthermore, one could even design a paper or electronic financial system with a fixed monetary supply, using no commodity at all, although to make this work one would need a system of government which was (unlike ours) financially trustworthy. And the result would be the same. Your Krugerrand would be worth squat. Permanently, finally, and absolutely. Written by moldbug on 2007-09-18 18:31:28</i> You know moldbug, reading your description above you might as well be describing the Canadian Dollar. Call it a fiat-commodity monetary supply. As long as the Government of Canada remains dificit adverse (12 year trend to date) you are good to go. Commodity cycle and fiscal conservatism explains the 48% appreciation in 5 years. The only flaw I see is the over exposure to the American Market. If Canada sold 80% of its exports to the rest of the world, then I would say the Loonie is the next reserve currency. LOL. Maybe Aussie dollar is better. Furthermore, one could even design a paper or electronic financial system with a fixed monetary supply, using no commodity at all, although to make this work one would need a system of government which was (unlike ours) financially trustworthy. And the result would be the same. Your Krugerrand would be worth squat. Permanently, finally, and absolutely.
Written by moldbug on 2007-09-18 18:31:28

You know moldbug, reading your description above you might as well be describing the Canadian Dollar. Call it a fiat-commodity monetary supply. As long as the Government of Canada remains dificit adverse (12 year trend to date) you are good to go. Commodity cycle and fiscal conservatism explains the 48% appreciation in 5 years.
The only flaw I see is the over exposure to the American Market. If Canada sold 80% of its exports to the rest of the world, then I would say the Loonie is the next reserve currency. LOL.

Maybe Aussie dollar is better.

]]> By: RebelEconomist http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100153 RebelEconomist Wed, 19 Sep 2007 11:39:29 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100153 Anonymous: If the spread over the risk free rate is compensation for expected loss, there is no reason why it should be related to the risk free rate itself. This question is not so straightforward after all! Anonymous:

If the spread over the risk free rate is compensation for expected loss, there is no reason why it should be related to the risk free rate itself.

This question is not so straightforward after all!

]]> By: moldbug http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100152 moldbug Wed, 19 Sep 2007 11:00:43 +0000 http://blogs.cfr.org/setser/2007/09/17/the-first-true-twenty-first-century-financial-crisis/#comment-100152 Guest: oui. Guest: oui.

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