The law of unintended consequences dictates that the deliberate decisions, choices, or actions of people, business, or government can lead to unanticipated or unintended consequences. In other words, although the purpose of a decision, choice, or action might be beneficial, that decision, choice, or action could have unanticipated effects—benign or adverse—that have little to do with the original intent behind that decision, choice, or action.
Such outcomes are possible because people lack prescience. No person, institution, or technology offers a crystal clear window to the future. Aside from natural phenomena, human behavior and interactions are so complex that the possible range of future effects of a given decision, choice, or action are all but infinite. As a result, a range of future effects is both unknown and unknowable.
Recent examples abound.
On March 30, 2009, The New York Times reported:
Amid the shaky economy of the last couple of years, housing has emerged as the central pillar of support. The market for housing has become less volatile and less prone to oversupply than before; it has also become the Federal Reserve's main lever for reviving the economy…
Housing prices have been increasing faster than general inflation for several years, and they have accelerated in recent months to their fastest real rate of gain in decades.
All this has bolstered consumer spending and helped salve the wounds that the falling stock market inflicted on households.
On July 20, 2009, The Washington Post reported:
The chemicals, called hydrofluorocarbons (HFCs), were introduced widely in the 1990s to replace ozone-depleting gases used in air conditioners, refrigerators and insulating foam.
They worked: The earth's protective shield seems to be recovering.
But researchers say what's good for ozone is bad for climate change. In the atmosphere, these replacement chemicals act like "super" greenhouse gases, with a heat-trapping power that can be 4,470 times that of carbon dioxide.
In both examples, the benefits seemed clear. The downside risks appeared to be limited, if they existed at all. Yet, housing proved to be no “Rock of Gibraltar” in the medium-term, as a giant bubble developed and burst, creating severe global synchronized recessions. In the latter case, addressing one environmental problem created a potential hazard for addressing another.
The law of unintended consequences is particularly relevant today. In the wake of unprecedented monetary and fiscal policy stimulus, policy makers need to be looking ahead to the future and developing scenarios for at least some of the possible unintended consequences that might arise. Given the enormous scope of policy decisions, the exercise needs to be particularly robust.
Possible unintended consequences include, but are not limited to:
• A return of reckless decision making on account of moral hazard resulting from bailouts and other extraordinary government assistance.
• The impact of increased market concentration that results from the failure of small financial services firms at a time when the federal government has acted as a guarantor for those that were deemed “too big to fail.” Amplification of such a risk should the federal government fail to develop an adequate regulatory response to the “too big to fail” issue.
• Political goals crowding out business objectives for firms that had received massive federal aid.
• A shift in investor sentiments concerning U.S. Government debt on account of a combination of increased debt from the fiscal stimulus and possible health care reform legislation should that legislation lack budget neutrality and fail to address the persistent growth of health expenditures in excess of nominal GDP, which amounts to a long-term expenditures bubble so to speak.
• A reappearance of excessive inflation from a delayed scaling back of the fiscal and monetary policy stimulus or the onset of a second recession from the premature or overly aggressive scaling back of the stimulus.
• A fundamental shift in risk perceptions that could lead to the emergence of a future housing bubble should the federal government make mortgage payments for unemployed homeowners.
• A slowing of the long-term economic growth trajectory should the federal government rely too heavily on tax hikes to fund new programs, finance existing mandatory spending programs without major reforms, or try to reduce its annual budget deficits.
• The impact on public- and private-sector finances and investment should long-term interest rates embark on a secular rise.
• The overall impact on economic growth, market risks, and innovation should the federal government’s post-financial crisis regulatory reforms result in excessive or inadequate regulation.
• A shift in investor sentiments concerning the U.S. dollar resulting from current and expected policy moves, economic outcomes, and a long-term diminishing of the dollar’s role as a world reserve currency.
• The fiscal and monetary policy proves sufficiently successful to bolster public confidence in government’s role of addressing economic crises that a new burst of economic euphoria unfolds.
It will be important that policy makers have a contingency plan for each of these scenarios, among others. In addition, the contingency plans will need to be sufficiently robust to lay out possible consequences of those measures, possible antidotes for those consequences, and contingency measures for those antidotes, as well.
In the post-housing bubble years, the law of unintended consequences is especially relevant given the magnitude of policy measures that have been undertaken and are likely to be pursued in the near-term. Although some risks are unknown or unknowable, it is imperative that policy makers take a rigorous approach toward identifying and addressing major risks in a proactive fashion. Neglect of this essential responsibility could have particularly high costs, especially when long-term economic and geopolitical trends are added to the mix.
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Showing posts with label housing bubble. Show all posts
Showing posts with label housing bubble. Show all posts
Tuesday, July 21, 2009
Friday, July 3, 2009
Failed Banks: A Snapshot
Yesterday, the Federal Deposit Insurance Corporation (FDIC) closed seven additional banks. That brought the number of closed banks this year to 52.
The assets held by the 80 failed banks presently amount to $413.8 billion. In addition, the International Monetary Fund (IMF) projects that writedowns of assets originated in the United States will amount to $2.7 trillion, most of which will be borne by financial institutions. As a result, dozens of additional banks could fail over the next 12-18 months.
A closer look at the failed institutions on the FDIC’s failed bank list reveals:
• The majority of failed banks are small- or medium-sized institutions holding assets of less than $1 billion.
• A disproportionate share of the failed banks is clustered in states in which the real estate market has suffered price declines of 40% or more or in states adjacent to those having such markets.
Size of Failed Banks: In the macroeconomic environment following the collapse of the nation’s housing bubble, which commenced during Summer 2006, 80 banks have failed to date.
If one defines a small bank as having less than $100 million in assets, a medium-sized bank as having $100 million to $999.9 million in assets, a large bank as holding $1 billion to $9.9 billion in assets, and a very large bank as having $10 billion or more in assets, one finds that small- or medium-sized banks account for 80% of failures to date. 60% of failed banks have been medium-sized financial institutions.
The median figure for assets held by the failed banks is presently $295 million. The smallest failed bank was Metropolitan Savings Bank with $15.8 million in assets. The largest was Washington Mutual Bank with $307 billion in assets.
Geographic Concentration of Failed Banks: Bank failure has clustered in a small number of states. Three states—California, Georgia, and Illinois—account for almost 50% of bank failures to date. Five states—California, Florida, Georgia, Illinois, and Nevada account for just over 60% of bank failures to date.
Through July 2, 23 states (46%) had one or more bank failures, while 27 (54%) had yet to record a bank failure. However, extraordinary federal assistance to such giant banks as Citibank and Bank of America, among others, may have limited a more widespread incidence of bank failures.
Data from the S&P/Case-Shiller Home Price Indices reveal that the clustering of failed banks has generally occurred in states with real estate markets that have experienced especially sharp price declines or adjacent states. Through April 2009, the seasonally-adjusted Case-Shiller 10-City Index has fallen 33.1% and the broader 20-City Index has declined by 32.0%. In a number of markets, real estate prices have fallen more than 40% from their peak. Select market date relevant to the five states that have seen a disproportionate incidence of bank failures follows:
Atlanta: 21.5%
Chicago: 26.8%
Detroit: 44.4%
Las Vegas: 51.8%
Los Angeles: 40.9%
Miami: 47.8%
San Diego: 42.2%
San Francisco: 45.6%
Tampa: 40.9%
The Georgia cluster may largely be the result of the decline in key sectors of Florida’s real estate market. Moreover, Georgia’s banks may have been hit harder than Florida’s on account of their persistently thinner cash holdings. The FDIC’s latest data showed that on March 31, 2009, cash accounted for 6.0% of assets in Florida’s banks and 4.5% of assets in Georgia’s banks. A year earlier, those figures were 3.3% and 2.4% respectively. Excessive derivatives exposures very likely contributed. In terms of a share of assets, Georgia's banks had more than 100 times the derivative exposure of Florida's financial institutions in both March 2008 and March 2009. In fact, in the March 2009 data, the derivatives positions held by Georgia's banks came to 106% of their assets.
The Illinois cluster of bank failures may be resulting from a combination of a weak, but not severely depressed, real estate market in Chicago and the severe manufacturing dislocations that are ongoing in the Great Lakes region. Reflecting the severity of the problems plaguing the region's manufacturing sector, the mean unemployment rate for Illinois, Indiana, Michigan, and Ohio was 11.4% in May. Nonetheless, Michigan has experienced far fewer bank failures than Illinois. Derivatives exposure may explain the difference. As a share of assets, Illinois banks had 3.7 times the derivative exposure as their Michigan counterparts in March 2008. In the most recent FDIC data, Illinois banks still had double the derivative exposure as Michigan's banks.
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The assets held by the 80 failed banks presently amount to $413.8 billion. In addition, the International Monetary Fund (IMF) projects that writedowns of assets originated in the United States will amount to $2.7 trillion, most of which will be borne by financial institutions. As a result, dozens of additional banks could fail over the next 12-18 months.
A closer look at the failed institutions on the FDIC’s failed bank list reveals:
• The majority of failed banks are small- or medium-sized institutions holding assets of less than $1 billion.
• A disproportionate share of the failed banks is clustered in states in which the real estate market has suffered price declines of 40% or more or in states adjacent to those having such markets.
Size of Failed Banks: In the macroeconomic environment following the collapse of the nation’s housing bubble, which commenced during Summer 2006, 80 banks have failed to date.
If one defines a small bank as having less than $100 million in assets, a medium-sized bank as having $100 million to $999.9 million in assets, a large bank as holding $1 billion to $9.9 billion in assets, and a very large bank as having $10 billion or more in assets, one finds that small- or medium-sized banks account for 80% of failures to date. 60% of failed banks have been medium-sized financial institutions.
The median figure for assets held by the failed banks is presently $295 million. The smallest failed bank was Metropolitan Savings Bank with $15.8 million in assets. The largest was Washington Mutual Bank with $307 billion in assets.
Geographic Concentration of Failed Banks: Bank failure has clustered in a small number of states. Three states—California, Georgia, and Illinois—account for almost 50% of bank failures to date. Five states—California, Florida, Georgia, Illinois, and Nevada account for just over 60% of bank failures to date.
Through July 2, 23 states (46%) had one or more bank failures, while 27 (54%) had yet to record a bank failure. However, extraordinary federal assistance to such giant banks as Citibank and Bank of America, among others, may have limited a more widespread incidence of bank failures.
Data from the S&P/Case-Shiller Home Price Indices reveal that the clustering of failed banks has generally occurred in states with real estate markets that have experienced especially sharp price declines or adjacent states. Through April 2009, the seasonally-adjusted Case-Shiller 10-City Index has fallen 33.1% and the broader 20-City Index has declined by 32.0%. In a number of markets, real estate prices have fallen more than 40% from their peak. Select market date relevant to the five states that have seen a disproportionate incidence of bank failures follows:
Atlanta: 21.5%
Chicago: 26.8%
Detroit: 44.4%
Las Vegas: 51.8%
Los Angeles: 40.9%
Miami: 47.8%
San Diego: 42.2%
San Francisco: 45.6%
Tampa: 40.9%
The Georgia cluster may largely be the result of the decline in key sectors of Florida’s real estate market. Moreover, Georgia’s banks may have been hit harder than Florida’s on account of their persistently thinner cash holdings. The FDIC’s latest data showed that on March 31, 2009, cash accounted for 6.0% of assets in Florida’s banks and 4.5% of assets in Georgia’s banks. A year earlier, those figures were 3.3% and 2.4% respectively. Excessive derivatives exposures very likely contributed. In terms of a share of assets, Georgia's banks had more than 100 times the derivative exposure of Florida's financial institutions in both March 2008 and March 2009. In fact, in the March 2009 data, the derivatives positions held by Georgia's banks came to 106% of their assets.
The Illinois cluster of bank failures may be resulting from a combination of a weak, but not severely depressed, real estate market in Chicago and the severe manufacturing dislocations that are ongoing in the Great Lakes region. Reflecting the severity of the problems plaguing the region's manufacturing sector, the mean unemployment rate for Illinois, Indiana, Michigan, and Ohio was 11.4% in May. Nonetheless, Michigan has experienced far fewer bank failures than Illinois. Derivatives exposure may explain the difference. As a share of assets, Illinois banks had 3.7 times the derivative exposure as their Michigan counterparts in March 2008. In the most recent FDIC data, Illinois banks still had double the derivative exposure as Michigan's banks.
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