international seminar on philosophy of education - Azim Premji
Financial Globalization and Instability Azim Premji Winter School January 15, 2013.
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Transcript of Financial Globalization and Instability Azim Premji Winter School January 15, 2013.
Financial Globalization and Instability
Azim Premji Winter SchoolJanuary 15, 2013
The challenge of financial globalization
• Globalization– Supply chains, Trade flows, Labor mobility– State law/policy vs. private international
• Financial– Capital Markets, Cross-border lending, FDI – Real/equilibrium vs. hierarchy/instability
• Global dollar funding market– E.g. Asian financial crisis, 2007-9 GFC
Shadow banking as characteristic institutional form
“Money market funding of
Capital market lending”
• Global funding of local lending• Market pricing, both money and capital• Key role of market-making institutions• Key role of central bank as backstop
Backstopping Global Funding Markets
Transformation of the Fed
A Bagehot Moment
Touching the Elephant
Economics View
• Monetary Walrasianism– Marschak, Patinkin, Tobin, Friedman: Md(.) = Ms
• QThM: MV=PT• NIPA: C+I+G=Y
• Arrow-Debreu Walrasianism– Intertemporal GE, DSGE:
β(1+r) = E{U’(Ct)/U’(Ct+1)}
• Practical Macro (accounting models, flows)– Flow of Funds:
∑iS(i,j) = ∑iU(i,j), ∑jS(i,j) = ∑jU(i,j)
Finance View
• Asset pricing: Pk = ∑(1/1+r)tCEt
• Modern:– CAPM, ERi = Rf + βi(ERm-Rf)– “Banking in a World without Money” (1970)
• Practical finance:– “Economics of the dealer function”– “Funding Liquidity and Market Liquidity”
The Money ViewResources from the Past
1. Copeland (1952): A Moneyflow Economy 2. Minsky (1957): The Survival Constraint
3. Hawtrey (1919): Hierarchy of Money and Credit, Inherent Instability
4. Hicks (1989): Centrality of the Dealer Function
5. Bagehot (1873): Central Bank as Dealer of Last Resort
Money and Banking defined
• Money = “transferable credit”– “inside” not “outside”– “public” and “private” hybrid– Payment system as credit clearing
• Banking = “swap of IOUs”– On-balance sheet: “loans create deposits”– Derivatives, e.g. Interest Rate Swaps– Banks as money dealers, market makers
Simple Hierarchy of Market Makers Asset Market Maker Price
Gold
Central Bank Exchange Rate
Currency
Banking System Par
Deposits
Security Dealers Interest Rate
Securities
Leverage vs. Liquidity
Equity Finance Bond Finance Money Finance
• Leverage: Equity vs. Bond – Modigliani-Miller Thm, vs. bankruptcy (insolvency)
• Liquidity: Bond vs. Money– Minsky: Hedge, Speculative, Ponzi (illiquidity)– Timing (mis)match of cash inflows/outflows
Assets Liabilities Assets Liabilities Assets Liabilities
PV(Future earnings)
Bonds 10Equity 90
PV(Future Earnings)
Bonds 90Equity 10
Bonds 100 Deposits 90Equity 10
Liquidity, Old and New
Money Finance Shadow Bank Asset Manager
• Survival Constraint, old and new– Payment system clearing– Collateral system clearing• Secured lending• Derivative settlement
Assets Liabilities Assets Liabilities Assets Liabilities
Bonds 100 Deposits 90Equity 10
Bonds 100CDS 0
‘Deposits’ 100 ‘Deposits’ 10 CDS 0Equity 10
Making Markets, Money and Risk
Capital Funding Bank Global Money Dealer Asset Manager
Derivative Dealer
Assets Liabilities Assets Liabilities Assets Liabilities
RMBSCDSIRSFXS
MM funding MM funding “deposits” “deposits” CapitalCDSIRSFXS
Assets Liabilities
Credit Default SwapsInterest Rate SwapsFX Swaps
Credit Default SwapsInterest Rate SwapsFX Swaps
Backstopping Markets: Funding and Market Liquidity
• Global Bank (money)
• Derivative Dealer (risk)
• Central Bank (or C5)
Assets Liabilities
MM fundingLiquidity put (funding)
“deposits”
Assets Liabilities
CDSIRSFXSLiquidity put (market)
CDSIRSFXS
Assets Liabilities
Liquidity put (funding)Liquidity put (market)
Regulation I: Systemic Risk “Inherent Instability of Credit”
• Hawtrey (1919) Currency and Credit• Minsky (1986) Stabilizing an Unstable
Economy• Adrian and Shin (2010) “Liquidity and
Leverage”
Centrality of the Dealer Function
• Treynor, 1987
Funding Liquidity and Market Liquidity
Boom Order Flow: Asset Manager > Capital Funding Bank
Bust Order Flow: Capital Funding Bank > Asset Manager
Bust Order Flow: Dealer Funding Stress
Fed Balance Sheet Transformed
Dec 15, 2011 Dec 15, 2011 (restated)
• Fed as Dealer of Last Resort– Global Money Dealer (OIS) [and FX swap]– Global Derivative Dealer (IRS, CDS)
Assets Liabilities Assets Liabilities
Treasuries $1.7MBS/GSE .9Other .3
TOTAL 2.9
Currency $1.0Reserves 1.6Other .3
TOTAL 2.9
[TBill $2.6[Tbond 2.6[Risky Secs .9Other .3
TOTAL 6.4?
Curr./Res. $2.6]Tbill 2.6]Tbond .9]Other .3
TOTAL 6.4?
Regulation II: Plumbing Collateral and Payment Flows
• Aitken and Singh (2010) “The (sizable) role of rehypothecation in the shadow banking system.”
• Minsky, “survival constraint”, settlement in the payments system
Why is Backstop Needed?
CFB GMD AM
DD
• Abstracting from Counterparty Risk– Lending (RMBS collateral as security)– Derivatives (Pre-funding and hedging)
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS 100CDS 0IRS 0
MM 100 MM 100 Deposit 100 Deposit 100 Capital 100CDS 0IRS 0
Assets Liabilities
CDS 0IRS 0
CDS 0IRS 0
Value Fluctuation and Collateral Flows
CFB GMD AM
DD
• Blocking a liquidity spiral (firesale of RMBS, CDS)– Lender of Last Resort to GMD, DD– Dealer of Last Resort for RMBS, CDS
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS 90CDS 10IRS 0
MM 100 MM 100 Deposit 100 Deposit 100 Capital 90CDS 10IRS 0
Assets Liabilities
CDS 10IRS 0
CDS 10IRS 0
Value Fluctuation and Payment Flows
CFB GMD AM
DD
• Blocking a liquidity spiral (firesale of RMBS, CDS)– Lender of Last Resort to GMD, DD– Dealer of Last Resort for RMBS, CDS
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS 90CDS 10IRS 0
MM 100 MM 100 Deposit 100 Deposit 100 Capital 90CDS 10IRS 0
Assets Liabilities
CDS 10IRS 0
CDS 10IRS 0
“Making” Markets, Money and Risk
Capital Funding Bank Global Money Dealer Asset Manager
Derivative Dealer
Assets Liabilities Assets Liabilities Assets Liabilities
RMBSCDS, IRS
MM funding MM funding
Liquidity Reserves
“deposits”
Capital Reserves
“deposits” CapitalCDS, IRS
Assets Liabilities
CDS, IRSLiquidity Reserves
CDS, IRSCapital Reserves
Implications for development
• Tapping global dollar funding markets, for domestic currency lending==FX risk
• National central bank as dollar liquidity backstop• C5 (and IMF) as crisis backstop for NCB– Japan, Switzerland, BoE, ECB, Fed?– IMF
• Normal backstop?– Payments system—home country NCB– Collateral system--???
Implications for development
• Tapping global dollar funding markets, for domestic currency lending==FX risk
• National central bank as dollar liquidity backstop• C5 (and IMF) as crisis backstop for NCB– Japan, Switzerland, BoE, ECB, Fed?– IMF
• Normal backstop?– Payments system—home country NCB– Collateral system--???
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