Friday, August 24, 2007

Limits to arbitrage

Good to look again at Schliefer and Vishney, The Limits of Arbitrage and Keynes' "Markets can remain irrational longer than you can remain solvent",
The context?

Brad DeLong with the coverage of John Meriwether's LTCM call for more money.

More on barriers to bottom fishing from Felix Salmon.

Thursday, August 23, 2007

The operation of the UK money market

The FT has a good overview of the operation of the UK money market and its interaction with the central bank amidst a story about a 'misunderstanding' between Barclays and HSBC.

Wednesday, August 22, 2007

The Marshall Plan

Naill Ferguson on Greg Behrman's 'The Most Noble Adventure'.

The total aid package was equivalent to less than three per cent of the recipient countries’ combined national income, and it represented less than a fifth of their gross investment.

To gauge the true importance of the Marshall Plan, it is crucial to get a sense of the amounts involved. Behrman writes, “From June 1947 to its termination at the end of 1951, the Marshall Plan provided approximately $13 billion to finance the recovery . . . of Western Europe.” This was less than half the Europeans’ initial request and four billion dollars less than President Truman’s initial proposal to Congress, but it was still serious money. Behrman computes that, in today’s dollars, “that sum equals roughly $100 billion, and as a comparable share of U.S. Gross National Product it would be in excess of $500 billion.” That’s actually an understatement. In fact, the total amount disbursed under the Marshall Plan was equivalent to roughly 5.4 per cent of U.S. gross national product in the year of Marshall’s speech, or 1.1 per cent spread over the whole period of the program, which, technically, dated from April, 1948, when the Foreign Assistance Act was passed, to June, 1952, when the last payment was made. A Marshall Plan announced today would therefore be worth closer to seven hundred and forty billion dollars. If there had been a Marshall Plan between 2003 and 2007, it would have cost five hundred and fifty billion. By comparison, actual foreign economic aid under the Bush Administration between 2001 and 2006 totalled less than one hundred and fifty billion, an average of less than 0.2 per cent of G.D.P.

Tuesday, August 21, 2007

Financial Engineering

Brad Stetser with an overview of the comments on financial engineering. This emphasises the uncertainty and the lack of liquidity that is affecting the market. It also highlights the importance of the Fed change to provide confidence that some funds, without access to the discount window, can use banks to push illiquid collateral through to the Fed in exchange for cash.

Monday, August 20, 2007

Saturday, August 18, 2007

The discount window

The FT has a story about how the Fed accompanied the cut in the discount rate with a reassurance to financial institutions that, other than the penalty rate, it would not discriminate against institutions that used the window. This certainly seems to be a change from the traditional position that would, it was suggested, mean additional scrutiny of banks that were frequent visitors to the window.

Thursday, August 16, 2007

Squeezing the regulatory balloon

Charles Wyplosz has a nice overview on the way that risk has been pushed out of the banking system into other sectors of the financial system. The problem is not so large, particularly in relation to the overall size of the system, but it is not clear where the risk now lies.

Wednesday, August 15, 2007

The meaning of liquidity

The Lex column today looks at the relative health of the IPO market, with VMware's stock rising strongly on its first day. This suggests that there is money available for firms. There is some "liquidity" in a broad sense, but there is no "liquidity" in the credit markets. The first use of the term is more associated with money and its availability. Central banks that peg their currencies still have funds to park and these will continue to flow. However, the second meaning of the term means that the market is not functioning in certain sectors. The weaker players have to be shaken out before any kind of normality returns. The FT notes today that the commercial paper market is also affected. The situation is similar to the caution and fear that was in the equity market when people were looking for another Enron or Worldcom.

Tuesday, August 14, 2007

Who are the noise-traders?

John Campbell "who are the noise traders?" Thanks to Mark Thoma

Using the estimated relation between trades of different sizes and institutional ownership, Ramadorai, Schwartz, and I construct daily institutional flows in individual stocks and find that they have several interesting characteristics. Daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sales, generate short-term losses but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings-announcement drift (the tendency for stock prices to continue moving in the same direction after an earnings surprise).

These results suggest that institutional investors do exploit certain well-known patterns in stock returns, but in doing so they trade urgently and move prices against themselves, causing prices to rise temporarily when they buy and, even more noticeably, to fall temporarily when they sell. As prices return to normal a day or two after institutional trading, institutions appear to make losses but in the longer run they earn profits from their abilities to pick stocks.

Be careful what you wish for....(2)

One thing that is often forgotten amongst the discussion of whether the EUR will take the USD role as the world's reserve currency is that the Bundesbank fought for years to prevent the D-mark taking on that role. The concern at the German central bank was that this could force them to draw their attention away from domestic price stability. Indeed, they had a good taste of that with the D-mark's role in the ERM with, notably, Norman Lamont famously haranguing Helmut Schlesinger in Bath for lower rates. In 1998 the Fed cut rates not just for the US economy but also to provide financial stability globally. Today the WSJ makes the point that the ability of the Bank of England to stand back and allow short term interest rates to rise owns something to the pound not being a reserve currency. It may also be related to the way the UK money market has an automatic penalty window that puts a 75bp cap on overnight rates. More on that here and here.

Sunday, August 12, 2007

Tuesday, August 07, 2007


Interesting input on Greg Clark's assetion that the industrial revolution is a result genetic rather than institutional change. I particulary like the assertion that the decline in real interest rates is a reflection of a more cautious and less hedonistic nature. Of course, there is a dispute that the higher the interest rate, the more interesting you are!

Brad DeLongtakes it up.

Wednesday, August 01, 2007

Feeding the demand for AAA credit

Flexi Salmon explains the way that AAA credit is created when there is a scarcity pushing prices up above the cost of putting together the pieces.