Economics Gone Wild
Gregory Morris & Jennifer Steffler
Social Science Journal, forthcoming
Abstract:
Media reports asserted that the 2008 foreclosure crisis unleashed a rash of pet relinquishments, especially in California's central valley, an area that had the highest U.S. foreclosure rates that year. However, reports on the foreclosure/relinquishment association relied on anecdotal evidence provided by animal shelters, which is known to be flawed since many people do not give a reason for relinquishment, or give a false reason. This study compares separate data sources for the central valley city of Turlock, 2008: foreclosure data from the Stanislaus County Recorder's Office (N = 235) and relinquishment data from the Turlock Animal Shelter (N = 248). Contrary to shelter driven data, these separate data sources reported only one shared address. However, spatial analyses show that foreclosures and relinquishments were concentrated in similar areas. Analyses also show that unaltered (non-spayed/neutered) dogs are more likely to be concentrated in lower socioeconomic (SES) areas. While our initial finding contradicts recent media reports, spatial analyses verify other research on the social problems associated with concentrated foreclosures, and lend support for policies designed to reduce breeding during heighted periods of foreclosure and other economic crises.
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The Role of Media in the Credit Crunch: The Case of the Banking Sector
Tomasz Piotr Wisniewski & Brendan Lambe
Journal of Economic Behavior & Organization, forthcoming
Abstract:
Using a Vector Autoregression framework, this paper investigates the dynamic relationship between the intensity of negative media speculation and the market performance of financial institutions. Evidence is provided that over the sub-prime crisis period pessimistic coverage Granger-caused the returns on banking indices, while causality in the opposite direction proved weaker. These findings may imply that journalists not only report on the state of economic reality, but also play an active role in creating it. Investors acting upon sentiment implicit in media reports would have been able to improve their investment performance, as measured by Sharpe ratios and Jensen's alphas.
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Illusion Therapy: How to Impose an Economic Shock without Social Pain
Tohid Atashbar
Journal of Policy Modeling, forthcoming
Abstract:
This study attempts to demonstrate how a government launched an economic structural reform plan that previous governments, fearing a serious social backlash, had been unable to implement over the course of 30 years. The findings show that the Iranian government used "illusion therapy", a package of econo-psychological techniques, to implement IMF-backed "shock" economic reforms to long-standing energy and food subsidies, without facing the expected social reaction.
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Gareth Campbell
Explorations in Economic History, forthcoming
Abstract:
The rationality of investors during asset price bubbles has been the subject of considerable debate. An analysis of the British Railway Mania, which occurred in the 1840s, suggests that investors may have been myopic, as their expectations were only accurate in the short-term, but they remained rational, as they acted in a utility maximising manner given their expectations. Investors successfully incorporated forecasts of short-term dividend changes into their valuations, but were unable to predict longer-term changes. When short-term growth is controlled for, it appears that the railways were priced consistently with the non-railways throughout the entire episode.
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The politician and his banker - How to efficiently grant state aid
Christa Hainz & Hendrik Hakenes
Journal of Public Economics, forthcoming
Abstract:
Politicians should spend money as efficiently as possible. But what is the best method of granting state aid to firms? We use a theoretical model with firms that differ in their success probabilities and compare different types of direct subsidies with indirect subsidies through bank loans. We find that, for a large range of parameters, subsidies through banks entail higher social welfare than direct subsidies, avoiding windfall gains to entrepreneurs and economizing on screening costs. For selfish politicians, subsidizing a bank has the additional advantage that part of the screening costs are born by private banks. Consequently, from a welfare perspective, politicians use subsidized banks inefficiently often.
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Financial Sector Ups and Downs and the Real Sector: Big Hindrance, Little Help
Joshua Aizenman, Brian Pinto & Vladyslav Sushko
NBER Working Paper, October 2011
Abstract:
We examine how financial expansion and contraction cycles affect the broader economy through their impact on 8 real economic sectors in a panel of 28 countries over 1960-2005, paying particular attention to large, or sharp, contractions and magnifying and mitigating factors. Overall, the construction sector is the most responsive to financial sector growth, with a number of others such as government, public utilities, and transportation also exhibiting significant sensitivity to lagged financial sector growth. Sharp fluctuations in the financial sector have asymmetric effects, with the majority of real sectors adversely affected by contractions but not helped by expansions. The adverse effects of financial contractions are transmitted almost exclusively by the financial openness channel with foreign reserves mitigating these effects with a sizeable (10 to 15 times greater) impact during sharp financial contractions. Both effects are magnified during particularly large financial contractions (with coefficients on interaction terms 2 to 3 times greater than when all contractions are considered). Consequent upon a financial contraction, the most severe real sector contractions occur in countries with high financial openness, relative predominance of construction, manufacturing, and wholesale and retail sectors, and low international reserves. Finally, we find that abrupt financial contractions are more likely to follow periods of accelerated growth, indicative of "up by the stairs, down by the elevator dynamics."
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Confidence, Crashes and Animal Spirits
Roger Farmer
Economic Journal, forthcoming
Abstract:
This article reformulates two important ideas from Keynes's General Theory. The first is that there may be a continuum of steady-state unemployment rates. The second is that beliefs select an equilibrium. I argue that search and matching costs in the labour market lead to the existence of a continuum of equilibria and I resolve the resulting indeterminacy by assuming that the beliefs of stock market participants are self-fulfilling. The article reconciles Keynesian economics with general equilibrium theory without invoking the assumption of frictions that prevent wages and prices from reaching their equilibrium levels.
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Towards a Program for Financial Stability
Robert Krainer
Journal of Economic Behavior & Organization, forthcoming
Abstract:
Fifty years ago Milton Friedman published a book entitled A Program for Monetary Stability. In it he outlined a number of suggestions for the conduct of monetary and fiscal policies that he thought would contribute to monetary stability and paripassu to price stability and a greater degree of output/employment stability. In this paper I review some of his policy prescriptions in light of the financial and economic crisis of 2007-2009. From the perspective of financial development the world today is much different from the world that Friedman knew in the late 1950's. In what way would his policy recommendations have to be modified to account for these changes in financial development? To stabilize the banking system we argue that his proposal for 100 percent reserve banking merits serious consideration in current policy discussions. To stabilize asset markets we propose two policies that Friedman would not likely endorse. The first is to reinstate selective credit controls in the areas of the securities markets, the real estate market, and various commodity markets. The second policy designed to dampen excessive variability in the stock market is for the Central Bank to carry out some open market operations in an index fund of equities.
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The Foreclosure Discount: Myth or Reality?
John Harding, Eric Rosenblatt & Vincent Yao
Journal of Urban Economics, forthcoming
Abstract:
Foreclosed properties sell at lower prices than do nearby non-distressed properties. Of particular concern, is whether there is a "stigma" foreclosure discount whereby REO properties sell at lower prices simply because they have been involved in foreclosure proceedings. To the extent that such a discount exists, arbitrage opportunities exist and the associated market failure has significant policy implications. We examine the foreclosure discount from a different perspective than prior researchers by comparing holding period returns earned by purchasers of REOs with those earned by purchasers of similar non-distressed properties. Our results show that the majority of REO purchasers do not earn economically significant excess returns. On average, the implied market discount is less than typical transaction costs. We also find evidence that REO properties and buyers vary systematically from their counterparts in the non-distressed market segment and that REO attribute prices differ from those of non-distressed properties. Overall, our evidence suggests that the market for REOs operates efficiently: lenders are not irrationally dumping REO properties and REO investors are not reaping extraordinary profits.
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Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy
George Aragon & Philip Strahan
Journal of Financial Economics, forthcoming
Abstract:
Hedge funds using Lehman as prime broker faced a decline in funding liquidity after the September 15, 2008 bankruptcy. We find that stocks held by these Lehman-connected funds experienced greater declines in market liquidity following the bankruptcy than other stocks; the effect was larger for ex ante illiquid stocks and persisted into the beginning of 2009. We find no similar effects surrounding the Bear Stearns failure, suggesting that disruptions surrounding bankruptcy explain the liquidity effects. We conclude that shocks to traders' funding liquidity reduce the market liquidity of the assets that they trade.
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Government Policy and Ownership of Financial Assets
Kristian Rydqvist, Joshua Spizman & Ilya Strebulaev
NBER Working Paper, October 2011
Abstract:
Since World War II, direct stock ownership by households across the globe has largely been replaced by indirect stock ownership by financial institutions. We argue that tax policy is the driving force. Using long time-series from eight countries, we show that the fraction of household ownership decreases with measures of the tax benefits of holding stocks inside tax-deferred plans. This finding is important for policy considerations on effective taxation and for financial economics research on the long-term effects of taxation on corporate finance and asset prices.
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Conservative traders, natural selection and market efficiency
Guo Ying Luo
Journal of Economic Theory, forthcoming
Abstract:
This paper examines the impact of conservative traders on market efficiency in an evolutionary model of a commodity futures market. This paper shows that the long-run market outcome is informationally efficient, as long as in every period there is a positive probability that entering traders are more conservative than their predecessors. Conservative traders are those who correctly predict the spot price with a positive probability, and more importantly, who in their mistakes err on the side of caution, and rarely overpredict the spot price as buyers, and underpredict the spot price as sellers. This result does not require entry of traders with better information than their predecessors.
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The Impact of Government Spending on the Private Sector: Crowding-out versus Crowding-in Effects
Davide Furceri & Ricardo Sousa
Kyklos, November 2011, Pages 516-533
Abstract:
We contribute to the empirical literature on the effect of government spending on economic activity, by assessing the impact of changes in government spending-GDP ratio on (the short-term growth rates of) private consumption and investment. We do this by analysing a panel sample of 145 countries from 1960 to 2007. The results of our paper suggest that government spending produces important crowding-out effects, by negatively affecting both private consumption and investment. The result is broadly robust to both country and time effects, and different econometric specifications. In addition, we show that the effect of government consumption on private consumption and investment does not depend on the phase of the business cycle, but differs substantially among regions. The differentiated effects of government consumption on private consumption and investment among geographical areas are extremely important and need to be further investigated. In particular, it would be interesting to assess to which extent the effect of government spending on consumption and investment depends on political and institutional variables (e.g. democracy, corruption, political stability) as well as macroeconomic variables (income, interest rates, degree of openness). We leave this challenging avenue for future research.
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Ending "Too Big To Fail": Government Promises vs. Investor Perceptions
Todd Gormley, Simon Johnson & Changyong Rhee
NBER Working Paper, October 2011
Abstract:
Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea's 1997-99 crisis, suggests an answer: No. Despite a general "no bailout" policy during the crisis, the largest Korean corporate groups (chaebol) - facing severe financial and governance problems - could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests "too big to fail" beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.
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Did Bankruptcy Reform Cause Mortgage Defaults to Rise?
Wenli Li, Michelle White & Ning Zhu
American Economic Journal: Economic Policy, November 2011, Pages 123-147
Abstract:
Homeowners in financial distress can use bankruptcy to avoid defaulting on their mortgages, since filing loosens their budget constraints. But the 2005 bankruptcy reform made bankruptcy less favorable to homeowners and therefore caused mortgage defaults to rise. We test this relationship and find that the reform caused prime and subprime mortgage default rates to rise by 23% and 14%, respectively. Default rates rose even more for homeowners who were particularly negatively affected by the reform. We calculate that bankruptcy reform caused mortgage default rates to rise by one percentage point even before the start of the financial crisis.
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How States Ration Flexibility: Tariffs, Remedies, and Exchange Rates as Policy Substitutes
Krzysztof Pelc
World Politics, October 2011, Pages 618-646
Abstract:
A close look at the commitments of World Trade Organization (wto) members presents a striking paradox. Most states could raise their duties significantly before falling afoul of their wto obligations. Moreover, such "binding overhang" varies between countries: some could more than double the amount of trade protection they offer overnight, whereas others are tightly constrained. What accounts for this variation? The author argues that more flexibility is not always better: obtaining it and subsequently using it are both costly. Rather than maximize flexibility, states thus seek an optimal amount. If they have access to policy space through other means, such as currency devaluations and trade remedies, they will exercise restraint in seeking binding overhang. The same supply-side logic holds at the domestic level: governments strategically withhold binding overhang from industries that are able to rely on trade remedies, despite the fact that these tend to have the greatest political clout.
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Testing the Global Financial Transparency Regime
J.C. Sharman
International Studies Quarterly, forthcoming
Abstract:
How can we tell whether rules that apply in theory actually do so in practice? Realists argue that the gap between what formal rules proscribe and their effectiveness may be particularly wide at the international level. Furthermore, dominant states may impose costly standards on others that they themselves choose not to implement. To test these propositions, the article assesses the effectiveness of international soft law standards prohibiting anonymous participation in the global financial system by seeking to break these standards. The findings indicate that the prohibition on anonymous corporations is relatively ineffective and is flouted much more in G7 countries than in tax havens. The article contributes to and extends the work of realist scholars in international political economy, both in their skepticism of formal rules and focus on the effects of power. Evidence is drawn from the author's solicitations and purchases of anonymous shell companies from 45 corporate service providers in 22 countries.