Finance & Development, June - Commodities in Boom
These include asset-backed commercial paper ABCP and certain triparty repo transactions. A firm with hard-to-sell illiquid financial assets, such as loans, mortgages, or receivables, might use ABCP to borrow at a lower cost or to move these assets off its balance sheet. This type of commercial paper can obtain a high credit rating if the assets are rated highly and if the special facility has adequate capital and lines of credit.
The capital is intended to cover unexpected losses on the assets, and the lines of credit take into account the difficulty of selling the underlying assets to meet cash needs. Some parts of the ABCP market had problems during the crisis. Standard commercial paper issuers—almost exclusively large nonfinancial corporations and banks—file quarterly financial statements that enabled investors to easily assess their credit condition. The credit risk on ABCP depended on, among other things, how the special purpose entity was set up, its credit enhancements, its liquidity backstop, and the value of the underlying assets—all likely to be less transparent and more complex than that of the straightforward commercial paper.
That hit the MMMF market, which holds more than one-third of outstanding commercial paper.
The triparty repo market proved to be much less reliable than the ordinary repo market for Treasury and agency securities. The triparty repo market is organized around one or two clearing banks that hold the collateral and transfer ownership from borrower to lender and back again when the loan is repaid. The triparty repo market was roiled by the collapse of markets for privately issued securities backed by mortgages. These securities made up a large share of the collateral in the triparty repo market. Once the market value and the credit ratings of these securities fell and the trading in these securities dried up, the triparty market suffered from both the higher haircuts the percentage by which a lender reduces the value of a security for collateral purposes needed to offset the volatility in the securitized debt market and the difficulty of pricing collateral that no longer had a market price.
Together the crises in the ABCP and triparty repo markets spread funding problems to banks, securities firms, and hedge funds that had used these money markets to fund investments.
Commodities in Boom
Today those markets have shrunk dramatically. Randall Dodd is a Financial Economist at the U. Letters may be edited. Please send your letters to fanddletters imf. Receive emails when we post new items of interest to you. Subscribe or Modify your profile. In particular, household consumption fell in high-debt economies by more than four times the amount that can be explained simply by the wealth effects of a fall in house prices.
Nor was the larger contraction simply driven by financial crises. The relationship between household debt and the contraction in consumption also holds for economies that did not experience a banking crisis around the time of the housing bust. It is also difficult for financial institutions to deleverage, and when they reduce debt the process can have equal or even worse macroeconomic effects than when households do it. Like households, though, banks can save little, except for cutting dividends and adjusting salaries.
They could repair their balance sheets by raising new equity, but are often reluctant to do so, and raising equity quickly can be costly. Instead, banks tend to repair balance sheets by shedding risky assets—that is, cutting back on new loans. But this response hurts the real economy because it reduces the availability of external financing.
If the financial sector is unwilling to provide new financing, a credit crunch can result, in which households and corporations are forced to deleverage, which in turn dampens investment and consumption. This can create a vicious cycle of declines in aggregate output and activity, less income, worse loans, and lower asset prices followed by more forced deleveraging.
There have been many cases historically where a big increase in private sector leverage ended in a financial crisis—in the Scandinavian and east Asian countries in the s, for example. Research has shown that financial crises of this type are followed by long, deep recessions in which crucial indicators such as unemployment and housing prices take far longer to hit bottom than after a normal recession. In some cases, though, recovery was fast because governments were able to substitute public purchasing for private buying.
For example, when faced with a big crisis in the early s, excessively indebted private borrowers in Sweden reduced their obligations by slashing spending. The Swedish government, which had a better credit standing than the private sector, increased its spending, running large fiscal deficits. At the same time, the government promptly restructured the financial system, and the central bank cut interest rates. Aided by an exchange rate adjustment, the collapse in activity was halted, the economy recovered, and the government could then start to reduce its debt.
Finance & Development
Unfortunately, for many advanced economies, this path is not as easily available today as in the s. Public debt levels were already high before the financial crisis, and many other liabilities—among them pensions and medical and other social services—loom large. The recessions caused large fiscal deficits, mainly due to the slow economic activity and further increases in expenditures, in part due to bank recapitalization as governments poured funds into banks and other financial institutions to keep them afloat.
This has been especially true for countries on the periphery of the euro area, where governments have had to retrench. Still, governments can play important roles.
Household debt restructuring programs such as those in the United States in the s and in Iceland today can help. Such policies can help avert self-reinforcing cycles of household defaults, additional house price declines, and increased contractions in output. Progress in deleveraging now varies by specific sectors of the economy and by country. Charts 1, 2, and 3 also provide a snapshot of the household and financial and corporate sector debt situation as of the third quarter of A simple comparison of current debt and leverage ratios with their preboom year levels suggests that households have a long way to go to repair their balance sheets.
The financial sector also needs to reduce its debt-to-GDP ratio and liabilities-to-equity ratio by quite a bit. Corporate sectors are generally in better shape. Some countries are a little further ahead in this process. In Germany, household debt to income has already declined.
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In the United States, the ratio has also fallen from its peak, although largely due to defaults that wiped out debts. In the United Kingdom, there has been some reduction in household debt to income since the crisis, although the level remains high. In most other countries, though, household debt has yet to return to its precrisis level or even to stop increasing.
For example, household leverage continues to rise in France and the Netherlands, in part because house prices have declined.
But the social and economic costs of white-collar crimes like embezzlement, tax evasion, insider trading, and bank fraud, while less obvious, can be massive as well. The bank, with the largest branch network in the country, was used to pay the security forces and other government workers, which made the threat of its collapse a matter of state concern. Behind these events was a history of interest-free loans to bank insiders and politically connected parties, their subsequent illegal investments in foreign real estate, and mysterious planeloads of cash jetting from Kabul to Dubai—money laundering at 30, feet.
As of October , more than a year after the government seized control of Kabul Bank, officials had recovered only a small portion of the missing money, and nobody has yet been criminally convicted. The story in Antigua and Barbuda was different, but the consequences for that small island economy were also dire. The purported high yields, of course, were not the result of some mystical market-beating investment that no other bank knew about. They could just get off the plane, make a deposit, and then go back to the transit lounge and wait for their return flight.
Shedding Debt
In March , Stanford was convicted of defrauding 30, investors in countries. They loaned money to themselves and secured loans from third parties with bank funds while concealing these nonperforming assets in a parallel set of books. The social and economic costs exceeded the direct cost of the bailouts; a rapid depreciation of the peso by approximately 65 percent led to very high inflation and a serious erosion of real incomes. These stories, of course, do not exhaust the catalog of techniques that criminals use to conceal the origins of their wealth. Making cash deposits of the proceeds of crime is a basic money laundering technique.
And just as the little blue characters from the cartoon have moved from television, to computer games, and now to the movie screen, the term remains alive in the anti—money laundering world. Highly sophisticated money laundering schemes often involve creating intricate layers of fictitious companies in multiple jurisdictions to conceal the actual criminal who owns and controls the assets. Such nontransparent offshore corporate entities were a centerpiece of the massive fraud committed by managers at the U.
The foregoing examples show how financial crimes such as corruption, tax crimes, financial fraud, and insider dealing—all predicate crimes to money laundering—can contribute to economic problems.