ASSET BUBBLES AND THE FINANCIAL CRISIS OF 2008? A. G. MALLIARIS Presented to the Xavier EMBA,...

transcript

ASSET BUBBLES AND THE FINANCIAL CRISIS OF 2008?A. G. MALLIARIS

Presented to the Xavier EMBA, November 26, 2008

• What are Asset Bubbles?

• Variety of Bubbles• Selected facts• Financial Crisis of

2007-8

What Are Asset Bubbles?

• Price of an Asset =

Fundamentals + Bubble

• What are the Fundamentals?

• Supply and Demand

• The Role of Information

• Reality of Uncertainty

Fundamentals

• Market Efficiency works well when information and arbitrage are costless

George Soros

• Theory of Reflexivity: From Fundamentals to Price or Price to Fundamentals?

• What happens when attention shifts from Fundamentals to Price?

• Expectations

Two Views

• Charles Kindleberger: Feedback

• Robert Shiller: Reversals

Preconditions for Bubbles

• Low Inflation

• Low Interest Rates

• Above average productivity

• Above average GDP growth

• NEW ECONOMY OUTLOOK

Variety of Bubbles

• Exchange Rates Bubbles

• Stock Market Bubbles

• Real Estate Bubbles

• Art Bubbles

• Commodities Bubbles

• Credit Bubbles

• Other

Who says we cannot recognize a bubble?

What are the basic questions?

• Do all booms/bubbles end in crashes?

• How are equity and real estate bubbles and crashes related?

• What are the economic consequences of bubble bursts

IMF Data

• Sample includes 14 Industrialized Countries

• Equity data from 1959 to 2002

• Housing data from 1970 to 2002

Methodological Issues

• Consider only top quartile of recorded peak to peak price increases as bubbles

• Consider only bottom quartile of recorded peak to trough price declines as bubble crashes

Findings about Stock Market

• 52 equity crashes found during sample

• On average, there was one crash per country every 13 years

• Sample average of crash was 45%

• Only one fourth of bubbles end up crashing

• Crashes unfold over 2.5 years

Findings about Housing Bubbles

• A Housing crash is defined as a 14% decline in prices

• Housing crashes occur less often than stock market crashes

• In the sub sample there were 20 housing vs.25 stock market crashes

• Housing crashes are clustered while equity crashes are evenly distributed

• Housing crashes lasted 4 years

Equity and Housing Crashes

• Stock market crashes may cause GDP declines of up to 4%

• Housing market crashes may cause GDP declines of up to 8%

Crashes and Consumption

• For every 100 dollars of wealth lost in a stock market crash consumers decrease their consumption by 4 dollars

• For every 100 dollars of wealth lost in housing, consumers decrease their consumption by 10 dollars

• Thus, housing crashes are more difficult than stock market crashes

Crashes and Banks

• Stock Market crashes do not always affect banks

• Housing crashes influence the banking sector more severely

• Housing crashes are most often the result of monetary tightening

Crashes and Corporations

• Stock Market bubbles accelerate business investments

• Stock Market bubbles increase equity financing and reduce debt financing

The Role of Monetary Policy

• The Monetary Policy Paradox: achieving low inflation may lead to bubbles

• Should Monetary Policy “target” bubbles?

• Does Monetary Policy “target” bubbles?

Are Bubbles Isolated?

• The Crash of the Internet Bubble in 2000-2001

• 9/11 Terrorist Attack

• Was Monetary Policy Easy for Too Long?

The Nasdaq Bubble and its Bursting

Fed Funds During the Past Decade

The Emergence of the Housing Bubble

Composite-10 CSXR

Possible Causes of the Recent Financial Crisis

• Easy Monetary Policy• Very Low Interest Rates• Large Global Savings• Housing Bubble• Subprime Mortgages• Role of Credit Agencies• Credit Bubble• Other

Monetary and Fiscal Policies

• Economic Stability: Definition?

• Financial Stability: Definition?

• Lender of Last Resort

• Fiscal Initiatives

Moving Forward

• From the Financial Sector

• To the Real Economy

• What are the Links?

The Financial Dimension

• What has happened to the U.S, stock market?

• Recent History

• The Very Long Run

S&P Yearly Returns

December 2008 value for S&P is the November 24 close.

Ratio of value of S&P 500 to the average earnings of those companies over the previous 10 years, adapted and updated from Shiller. Blue line: ratio of monthly average S&P 500 index (deflated by current CPI) to 10-year average of most recent monthly earnings (each deflated by CPI for that month). April-June 2008 earnings from straight-line monthly interpolation of 12-month as reported quarterly earnings from Standard & Poor's. November 2008 value for S&P is the November 12 close. Red line: historical average (16.34).

The Impact on GDP

• Shorter Perspective

• Longer Perspective

Global Perspectives

• Past Crises Were in Developing Economies

• Major US Crisis

• How to Establish Global Financial and Economic Stability

Conclusions

• U.S. Driven Global Financial Crisis• Multiple Causes• Double Feedback between Financial and Real

Sectors• Multiple Global Feedback• Balance Between Bail-outs and Bankruptcies• What Role for Regulation?• Global Stability?

ASSET BUBBLES AND THE FINANCIAL CRISIS OF 2008? A. G. MALLIARIS Presented to the Xavier EMBA,...

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