tag:blogger.com,1999:blog-8764541874043694159.post2301011793355303685..comments2024-03-28T07:33:46.151+00:00Comments on Coppola Comment: Explaining Piketty: inequality and the financial crisisFrances Coppolahttp://www.blogger.com/profile/09399390283774592713noreply@blogger.comBlogger15125tag:blogger.com,1999:blog-8764541874043694159.post-73253770628501260462014-09-03T10:32:49.376+01:002014-09-03T10:32:49.376+01:00a Century Financial was a mortgage originator spec...a Century Financial was a mortgage originator specialising in subprime lending. It originated subprime mortgage loans, bundled them up and sold them on. Its business model depended on continual sales of subprime mortgage securities to free up capital and generate funds for further lending. Northern Rock in the UK had a very similar business model. This is nothing like a hedge fund, though - the securitisation engine is more like a GSE. Really, NCF and NR were both acting like private sector versions of Fannie Maeallabouthttp://www.allaboutmeego.orgnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-58916117981632938432014-07-12T18:09:15.023+01:002014-07-12T18:09:15.023+01:00http://www.investopedia.com/articles/07/new-centur...http://www.investopedia.com/articles/07/new-century.asp<br /><br />"2004 - Converts to a real estate investment trust; listed on the NYSE; originates $42.2 billion in mortgages"<br /><br />Why is New Century Financial an "ordinary bank" and not a "shadow bank"?<br /><br />Which brings up the questions:<br /><br />What is an "ordinary bank"?<br /><br />What is a "shadow bank"?<br /><br />---Fed UpAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-55590324314718363262014-07-12T14:30:31.358+01:002014-07-12T14:30:31.358+01:00No, it was a specialist mortgage bank. Like Countr...No, it was a specialist mortgage bank. Like Countrywide - which also went bust in the crisis and was acquired by Bank of America.Frances Coppolahttps://www.blogger.com/profile/09399390283774592713noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-47108927209335991412014-07-12T02:28:31.075+01:002014-07-12T02:28:31.075+01:00New Century Financial should be considered a "...New Century Financial should be considered a "shadow bank" and not an "ordinary bank", right?<br /><br />---Fed UpAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-45984754067490076692014-07-11T01:01:49.586+01:002014-07-11T01:01:49.586+01:00I can indeed help.....
A leveraged hedge fund is ...I can indeed help.....<br /><br />A leveraged hedge fund is essentially a fund that is hedging part of its portfolio with borrowed money, often as part of a long/short strategy. You could argue that this is what commercial banks do, actually: they borrow at a low rate, lend at a higher rate and make a profit on the spread. Though we don't usually think of banks as hedge funds. Perhaps we should.<br /><br />Banks are by definition highly leveraged - a bank that wasn't leveraged would be lending only from own equity (we don't have any banks like that at the moment, though some people would like to see them). Capital requirements attempt to limit banks' leverage, but even so the leverage of a typical bank is far higher than any corporation or indeed most leveraged hedge funds. LTCM, which was far more highly leveraged than the vast majority of hedge funds, had a leverage ratio of 4% when it failed, which is about average for a bank. <br /><br />New Century Financial was a mortgage originator specialising in subprime lending. It originated subprime mortgage loans, bundled them up and sold them on. Its business model depended on continual sales of subprime mortgage securities to free up capital and generate funds for further lending. Northern Rock in the UK had a very similar business model. This is nothing like a hedge fund, though - the securitisation engine is more like a GSE. Really, NCF and NR were both acting like private sector versions of Fannie Mae. <br /><br />Leverage is a meaningless concept for a central bank. They don't borrow. They issue currency ex nihilo and they back it with various categories of reserve assets, including their own governmment's debt, the debt of other governments (FX reserves), gold and (sometimes) private sector assets. The liabilities of a central bank are the monetary base, which behaves more like equity than debt: it is undated, zero-coupon and callable (the Fed can withdraw it at any time without notice), and you have no right of redemption - you just try redeeming a banknote and see what you get. <br /><br />Does that help?<br />Frances Coppolahttps://www.blogger.com/profile/09399390283774592713noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-5568706340673604212014-07-10T18:01:50.553+01:002014-07-10T18:01:50.553+01:00Thanks for that link.
Actually, Piketty's res...Thanks for that link.<br /><br />Actually, Piketty's response at that link does not address the points I raised above. He does tangentially address the issue of 401(k) plans (excluding, apparently all other private pension arrangements) arguing that income from these assets is included in income when distributed. However, that misses the point. It ignores the fact that, whether these assets generate current income or not, they are a form of wealth and savings. A very significant form, especially for the "non-rich". (As is other vested rights in annuities, such as social security). It is just as much a form of savings and wealth as a stock portfolio that does not currently pay a dividend. It appears that the latter finds itself into Piketty's calculation of "wealth", but private pension savings do not. And, strangely, Piketty does not seem to view any amount distributed from private pension arrangements as "income from capital". That does not make a lot of sense to me. <br /><br />And, more directly to the point raised here by Coppola, It also doesn't make a lot of sense to me to ignore the fact that the funds these pension savings represent is made available for lending to the middle class and the poor to buy houses and other things. The very fact that they are undistributed makes them available to do just that.Vivian Darkbloomhttps://www.blogger.com/profile/18362419878968863283noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-29966870477148995652014-07-10T14:42:24.037+01:002014-07-10T14:42:24.037+01:00Note that Alan Reynolds has been attacking Piketty...Note that Alan Reynolds has been attacking Piketty on similar grounds for a very long time. Here is a link to a 2006 response by Piketty (and Saez) to one of Reynolds' earlier critiques: http://eml.berkeley.edu/~saez/answer-WSJreynolds.pdf<br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-64460490847747266702014-07-10T13:29:27.788+01:002014-07-10T13:29:27.788+01:00"So we can now understand the story that Pike..."So we can now understand the story that Piketty's paragraph is telling. During the years before the financial crisis, as top incomes continued to rise while low-to-middle incomes stagnated, capital available for investment grew."<br />...<br /><br />"And it is now easy to see why Piketty argues that US inequality contributed to the financial instability that led to Lehman. You may disagree - but it is a compelling argument."<br /><br />The argument is not compelling if it is based on faulty data. And Piketty is already backing away from the US data presented in the book (the one containing the quote that is analyzed here).<br /><br />The argument here seems to be that due to rising inequality of incomes, "the rich" had more money to save, and those savings were forced on unsuspecting low- and middle-class borrowers (but, at least, the government role in such lending is here acknowledged).<br /><br />Where did Piketty get his US numbers? Primarily from US tax return data. That data is suspect, and indeed wrong, for several reasons:<br /><br />1. The US tax return data Piketty uses does not include private pension savings. Those savings rose from $875 billion in 1984 to $12.4 trillion in $12.4 trillion in 2012 (a more recent report puts this at more than $20 trillion today). These savings within these plans and the income within them (IRA's, 401(k)'s, defined benefit plans, etc.) don't show up on US tax returns and therefore were not counted by Piketty in his analysis of "increased inequality". Due to the monetary restrictions on contributions to those plans, I think it can be safely concluded that they belong predominately to the under 1 percent or 0.1 percent class (the latter, particularly). While its true that many, if not most, Americans under-save for their retirements, this is a significant sum to omit from your analysis. And yet, that sum, representing largely the savings of middle-class Americans is just (if not more, due to the more conservative investment strategies) available for indirect lending back to those same middle-class folks and lower-income folks. It's easy to attribute a higher proportion of savings (and indeed, inequality) when one omits the largest source of savings the lower and middle classes have. The crisis hit just as large numbers of baby boomers were approaching retirement age.<br /><br />2. While tax-deferred income under private pension plans does not appear in US tax return data, more recently municipal bond interest does (this type of interest is tax-exempt at the federal level, but must be reported on tax returns). The change in reporting policy thus tends to lead to the erroneous conclusion that income and wealth inequality increased.<br /><br />3. Due to declining personal income tax rates in the United States and due to the introduction of tax-transparent limited liability companies (LLC's) much business investment shifted from taxable "C" corporations to flow-thru entities such as LLC's (and Subchapter S corporations and general and limited partnerships). From the mid-1990's a much greater percentage of business income has been earned through these entities and thus the income reported directly by "rich" owners on their tax returns. Prior to this, much of that income was not directly reported on individual returns because it was earned (but not distributed) within the corporate solution. Failure to account for these changes means that Piketty exaggerates the change in inequality over the past two decades or so. Simply because increased accounting income is reported on tax returns of "the rich", that does not mean it is available for "savings", much less than it represents an increase in "income" and therefore "wealth" from periods when it was reported as income of a taxable corporation owned by its "rich" shareholders><br /><br />So, for these reasons (and more), I don't find the data or the argument "compelling".<br /><br />There is more on this in today's WSJ.Vivian Darkbloomhttps://www.blogger.com/profile/18362419878968863283noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-20097669198106957932014-07-08T18:52:11.943+01:002014-07-08T18:52:11.943+01:00I don't think it is necessarily true that risi...I don't think it is necessarily true that rising inequality causes falling demand. After all, there can be rising income inequality even when all incomes are actually rising - just some rising faster than others. Under these circumstances both spending AND saving may actually increase even though income inequality is rising. We would expect this in a strongly growing economy with no financial repression (so not China or Germany!). It might be associated with high inflation. <br /><br />Rising income inequality might be associated with falling AD if real incomes for the majority are falling faster than real incomes at the top. But the problem is falling real incomes, not rising inequality per se. Curtailing top incomes to reduce inequality wouldn't necessarily mean income rises at the lower end, which is what is really needed. In focusing too much on inequality we are in serious danger of missing the real problems. Frances Coppolahttps://www.blogger.com/profile/09399390283774592713noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-16380211557752374452014-07-08T16:24:08.225+01:002014-07-08T16:24:08.225+01:00Hah. Well, Piketty did say that perhaps his book s...Hah. Well, Piketty did say that perhaps his book should have been longer! Frances Coppolahttps://www.blogger.com/profile/09399390283774592713noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-68521984214571740462014-07-08T14:38:47.025+01:002014-07-08T14:38:47.025+01:00You've used about 1,200 words to "explain...You've used about 1,200 words to "explain" what Piketty wrote in under 100 words. i don't know what the opposite of a precis is, but this certainly qualifies. I look forward to the 8,000 page explanation of Piketty's whole book! Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-11101057661735317002014-07-08T14:06:52.275+01:002014-07-08T14:06:52.275+01:00Thanks a lot for your answer! Maybe I was wrong to...Thanks a lot for your answer! Maybe I was wrong to use the term paradox of thrift. What I meant is if income inequality increases, aggregate demand c.p. falls. If firms expect lower demand, they decrease their investment. Investment drives savings and therefore savings decrease. What do you think?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-45289695902277786672014-07-08T13:52:03.882+01:002014-07-08T13:52:03.882+01:00The paradox of thrift can be described thus: "...The paradox of thrift can be described thus: "when everyone is trying to save rather than spend, no-one can". Inequality causes increased saving because those with the highest incomes save more, not because everyone does: indeed if the increase in top saving is matched by increased borrowing at lower incomes there may be no change in net saving. The paradox of thrift would only apply if saving instead of spending became fashionable at all income levels. <br /><br />What I think you may be referring to is the tendency of the poor to cut discretionary spending when incomes fall or borrowing sources dry up. This does indeed take demand out of the economy, causing stagnation.<br /><br />The debt bubble was a consequence of secular stagnation, not the other way round.Frances Coppolahttps://www.blogger.com/profile/09399390283774592713noreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-19370758455323063102014-07-08T13:00:20.926+01:002014-07-08T13:00:20.926+01:00"When low-to-middle incomes stagnate but top ..."When low-to-middle incomes stagnate but top incomes continue to rise, saving naturally increases." Are you sure about this? What about the paradox of thrift? In my opinion, higher income inequality c.p. leads to a decrease in demand, output and saving. This is also a powerful explanation for secular stagnation following the debt bubble.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8764541874043694159.post-81487432903252439042014-07-08T09:56:28.961+01:002014-07-08T09:56:28.961+01:00Great explanation, thank you so much! Wish we coul...Great explanation, thank you so much! Wish we could bring your systemic view to a larger public and have us all broaden our view on how we are part of these larger dynamics. Sandra Gevaerthttp://www.qyo.nlnoreply@blogger.com