As I reflect and read more on the credit crisis, some of the comments by Fed Chairman Bernanke and PIMCO economist Paul McCulley resonate. McCulley is the economist who has focused thinking on the credit crisis as a Minsky moment. Bernanke has focused on the link between regulation of financial institutions and monetary policy.
We are faced with a procyclical credit cycle where financial institutions move from restrictive behavior to a euphoria of speculative lending as they chase declining lending opportunities at lower risk adjusted prices. The lending cycle causes collateral prices to be bid so that the lending becomes increasingly risky and tied to the continual increase in asset prices. Unfortunately, if you restrict lending during the downturn in the credit cycle, delevering will reduce any positive impact from lowering interest rates.
What may be good regulatory policy for a single institution may be harmful to the economy as a whole when there are systemic risk in asset prices. Consequently, there needs to be a macroprudential sense toward regulatory arrangements. Under this context, the Fannie and Freddie bailout does not change the incentive structure and dynamic of the credit crisis. In fact, fiscal prudence may only exacerbate the problem.
Yet, at this time the world is feeling better. Unfortunately, this short-term warm feeling will not chane the long-term down cycle of delevering and further adjustment in the credit cycle.
We are faced with a procyclical credit cycle where financial institutions move from restrictive behavior to a euphoria of speculative lending as they chase declining lending opportunities at lower risk adjusted prices. The lending cycle causes collateral prices to be bid so that the lending becomes increasingly risky and tied to the continual increase in asset prices. Unfortunately, if you restrict lending during the downturn in the credit cycle, delevering will reduce any positive impact from lowering interest rates.
What may be good regulatory policy for a single institution may be harmful to the economy as a whole when there are systemic risk in asset prices. Consequently, there needs to be a macroprudential sense toward regulatory arrangements. Under this context, the Fannie and Freddie bailout does not change the incentive structure and dynamic of the credit crisis. In fact, fiscal prudence may only exacerbate the problem.
Yet, at this time the world is feeling better. Unfortunately, this short-term warm feeling will not chane the long-term down cycle of delevering and further adjustment in the credit cycle.
No comments:
Post a Comment