COVID-19 Archives – Page 2 of 2

New Thinking in the News

Can countries safely print money to combat the crisis? What ethical principles can we rely on in this pandemic? What policy does Soros think the US should implement right away? How does an understanding of gender theory improve our approach to doing economics? This week’s recommended read tackle these themes, and more. Enjoy.

1 | Finding the ‘Common Good’ in a Pandemic in the New York Times, with Michael Sandel

“Think about the two emblematic slogans of the pandemic: “social distancing” and “we’re all in this together.” In ordinary times, these slogans point to competing for ethical principles — setting ourselves apart from one another, and pulling together. As a response to the pandemic, we need both. We need to separate ourselves physically from our friends and co-workers in order to protect everyone, to prevent the virus from spreading. But ethically, these slogans highlight two different approaches to the common good: going it alone, with each of us fending for ourselves, versus hanging together, seeking solidarity. In a highly individualistic society like ours, we don’t do solidarity very well, except in moments of crisis, such as wartime.”

2 | Can We Print Infinite Money to Pause the Economy During the Coronavirus Pandemic? in Vice, featuring David Weil

“What are the consequences of just giving everyone enough cash to survive the next few months? […] It’s complicated.”

3 | With working Americans’ survival at stake, the US is bailing out the richest, in the Guardian, by Morris Pearl and Bill Lazonick

“Amid a humanitarian crisis compounded by mass layoffs and collapsing economic activity, the last course our legislators should be following is the one they appear to be on right now: bailing out shareholders and executives who, while enriching themselves, spent the past decade pushing business corporations to the edge of insolvency.”

4 | George Soros: Guarantee paychecks for all workers displaced by coronavirus to save the economy in the LA Times by George Soros and Eric Beinhocker

“History has shown the strategy works. Thanks to Germany’s “Kurzarbeit” program, unemployment there actually fell from 7.9% to 7% during the Great Recession, while average unemployment in other major developed economies rose by 3%. As a result, the German economy recovered more quickly than those of many other countries.”

5 | The Human-Capital Costs of the Crisis, in Project Syndicate, by Barry Eichengreen

“Unemployment and hardship can also lead to demoralization, depression, and other psychological traumas, lowering affected individuals’ productivity and attractiveness to employers. We saw this in the 1930s, not just in declining rates of labor force participation but also in rising rates of suicide and falling rates of marriage. Here, too, one worries especially about the US, given its relatively limited safety net, its opioid crisis, and its “deaths of despair.”

6 | Ecological and Feminist Economics, an interview with Julie Nelson in Real World Economics Review

“…the mainstream discipline of economics relies on a deeply gendered belief about what makes for good science. Economists like to think of economic life as confined to the market, driven by self-interest and competition, rational and controllable, and intrinsically governed by mathematics and physics-like “laws” not because the economy is intrinsically that way but because these ways of seeing it are all associated with masculinity and toughness. What about production in the home? Care for others and the environment? Human emotions, in the face of a future that is fundamentally unknowable? Ways of understanding that require hands-on investigation and broader sorts of reasoning? Acknowledging these things is, by comparison, seen as womanly and weak. And so those parts of reality and those parts of good science – which I define as open-minded and systematic investigation – were banished.”

Every week, we share a few noteworthy articles that showcase the work of new economic thinkers around the world. Subscribe to receive these shortlists directly to your email inbox.

In a World Where Banks Do Not Aspire to be Intermediaries, Is It Time to Cut Out the Middlemen? (Part I)

“Bankers have an image problem.”
Marcy Stigum

By Elham Saeidinezhad | Despite the extraordinary quick and far-reaching responses by the Fed and US Treasury, to save the economy following the crisis, the market sentiment is that “Money isn’t flowing yet.” Banks, considered as intermediaries between the government and troubled firms, have been told to use the liberated funds to boost financing for individuals and businesses in need. However, large banks are reluctant, and to a lesser extent unable, to make new loans even though regulators have relaxed capital rules imposed in the wake of the last crisis. This paradox highlights a reality that has already been emphasized by Mehrling and Stigum but erred in the economic orthodoxy.

To understand this reluctance by the banks, we must preface with a careful look at banking. In the modern financial system, banks are “dealers” or “market makers” in the money market rather than intermediaries between deficit and surplus agents. In many markets such as the UK and US, these government support programs are built based on the belief that banks are both willing and able to switch to their traditional role of being financial intermediaries seamlessly. This intermediation function enables banks to become instruments of state aid, distributing free or cheap lending to businesses that need it, underpinned by government guarantees. This piece (Part l) uses the Money View and a historical lens to explain why banks are not inspired anymore to be financial intermediaries. In Part ll, we are going to propose a possible resolution to this perplexity. In a financial structure where banks are not willing to be financial intermediaries, central banks might have to seriously entertain the idea of using central bank digital currency (CBDC) during a crisis. Such tools enable central banks to circumvent the banking system and inject liquidity directly to those who need it the most.

Stigum once observed that bankers have, at times, an image problem. They are seen as the culprits behind the high-interest rates that borrowers must pay and as acting in ways that could put the financial system and the economy at risk, perhaps by lending to risky borrowers, when interest rates are low. Both charges reflect the constant evolution in banks’ business models that lead to a few severe misconceptions over the years. The first delusion is about the banks’ primary function. Despite the common belief, banks are not intermediaries between surplus and deficit agents anymore. In this new system, banks’ primary role is to act as dealers in money market securities, in governments, in municipal securities, and various derivative products. Further, several large banks have extensive operations for clearing money market trades for nonbank dealers. A final important activity for money center banks is foreign operations of two sorts: participating in the broad international capital market known as the Euromarket and operating within the confines of foreign capital markets (accepting deposits and making loans denominated in local currencies).

Structural changes that have taken place on corporates’ capital structure and the emergence of market-based finance have led to this reconstruction in the banking system. To begin with, the corporate treasurers switched sources of corporate financing for many corporates from a bank loan to money market instruments such as commercial papers. In the late 1970s and early 1980s, when rates were high, and quality-yield spreads were consequently wide, firms needing working capital began to use the sale of open market commercial paper as a substitute for bank loans. Once firms that had previously borrowed at banks short term were introduced to the paper market, they found that most of the time, it paid them to borrow there. This was the case since money obtained in the credit market was cheaper than bank loans except when the short-term interest rate was being held by political pressure, or due to a crisis, at an artificially low level.

The other significant change in market structure was the rise of “money market mutual funds.” These funds provide more lucrative investment opportunities for depositors, especially for institutional investors, compared to what bank deposits tend to offer. This loss of large deposits led bank holding companies to also borrow in the commercial paper market to fund bank operations. The death of the deposits and the commercial loans made the traditional lending business for the banks less attractive. The lower returns caused the advent of the securitization market and the “pooling” of assets, such as mortgages and other consumer loans. Banks gradually shifted their business model from a traditional “original and hold” to an “originate-to-distribute” in which banks and other lenders could originate loans and quickly sell them into securitization pools. The goal was to increase the return of making new loans, such as mortgages, to their clients and became the originators of securitized assets.

The critical aspect of these developments is that they are mainly off-balance sheet profit centers. In August 1970, the Fed ruled that funds channeled to a member bank that was raised through the sale of commercial paper by the bank’s holding company or any of its affiliates or subsidiaries were subject to a reserve requirement. This ruling eliminated the sale of bank holding company paper for such purposes. Today, bank holding companies, which are active issuers of commercial paper, use the money obtained from the sale of such paper to fund off-balance sheet, nonbank, activities. Off-balance sheet operations do not require substantial funding from the bank when the contracts are initiated, while traditional activities such as lending must be fully funded. Further, most of the financing of traditional activities happens through a stable base of money, such as bank capital and deposits. Yet, borrowing is the primary source of funding off-balance sheet activities.

To be relevant in the new market-based credit system, and compensate for the loss of their traditional business lines, the banks started to change their main role from being financial intermediaries to becoming dealers in money market instruments and originators of securitized assets. In doing so, instead of making commercial loans, they provide liquidity backup facilities on commercial paper issuance. Also, to enhance the profitability of making consumer loans, such as mortgages, banks have turned to securitization business and have became the originators of securitized loans.

In the aftermath of the COVID-19 outbreak, the Fed, along with US Treasury, has provided numerous liquidity facilities to help illiquid small and medium enterprises. These programs are designed to channel funds to every corner of the economy through banks. For such a rescue package to become successful, these banks have to resume their traditional financial intermediary role to transfer funds from the government (the surplus agents) to SMEs (the deficit agents) who need cash for payroll financing. Regulators, in return, allow banks to enjoy lower capital requirements and looser risk-management standards. On the surface, this sounds like a deal made in heaven.

In reality, however, even though banks have received regulatory leniency, and extra funds, for their critical role as intermediaries in this rescue package, they give the government the cold shoulder. Banks are very reluctant to extend new credits and approve new loans. It is easy to portray banks as villains. However, a more productive task would be to understand the underlying reasons behind banks’ unwillingness. The problem is that despite what the Fed and the Treasury seem to assume, banks are no longer in the business of providing “direct” liquidity to financial and non-financial institutions. The era of engaging in traditional banking operations, such as accepting deposits and lending, has ended. Instead, they provide indirect finance through their role as money market dealers and originators of securitized assets.

In this dealer-centric, wholesale, world, banks are nobody’s agents but profits’. Being a dealer and earning a spread as a dealer is a much more profitable business. More importantly, even though banks might not face regulatory scrutiny if these loans end up being nonperforming, making such loans will take their balance sheet space, which is already a scarce commodity for these banks. Such factors imply that in this brave new world, the opportunity cost of being the agent of good is high. Banks would have to give up on some of their lucrative dealing businesses as such operation requires balance sheet space. This is the reason why financial atheists have already started to warn that banks should not be shamed into a do-gooder lending binge.

Large banks rejected the notion that they should use their freed-up equity capital as a basis for higher leverage, borrowing $5tn of funds to spray at the economy and keep the flames of coronavirus at bay. Stigum once said that bankers have an image problem. Having an image problem does not seem to be one of the banks’ issues anymore. The COVID-19 crisis made it very clear that banks are very comfortable with their lucrative roles as dealers in the money market and originators of assets in the capital market and have no intention to be do-gooders as financial intermediaries. These developments could suggest that it is time to cut out banks as middlemen. To this end, central bank digital currency (CBDC) could be a potential solution as it allows central banks to bypass banks to inject liquidity into the system during a period of heightened financial distress such as the COVID-19 crisis.

Elham Saeidinezhad is lecturer in Economics at UCLA. Before joining the Economics Department at UCLA, she was a research economist in International Finance and Macroeconomics research group at Milken Institute, Santa Monica, where she investigated the post-crisis structural changes in the capital market as a result of macroprudential regulations. Before that, she was a postdoctoral fellow at INET, working closely with Prof. Perry Mehrling and studying his “Money View”. Elham obtained her Ph.D. from the University of Sheffield, UK, in empirical Macroeconomics in 2013. You may contact Elham via the Young Scholars Directory

The Social Determinants of Health in the Age of COVID19

With the ongoing pandemic and economic crisis, there is much to discuss. To inform the debates taking place in the YSI community, Luisa Scarcella and Aleksandar Stojanović have kicked off a special webinar series in which to unpack some of the accompanying challenges. For the first session, Luisa invited Professor Sir Michael Marmot, Professor of Epidemiology and Public Health at University College London, Director of the UCL Institute of Health Equity, and Past President of the World Medical Association. His work reveals the interrelated nature of health and socioeconomic inequality; a highly relevant topic today.

When economists talk about health, they usually talk about the healthcare system. They don’t often talk about what makes people sick in the first place. But Marmot does, and he finds that our people’s health is closely tied to the socio-economic conditions they are in; lower socio-economic conditions lead to worse health, and increasing socioeconomic inequality yields a widening health gap. His findings are compelling:

In the developed world, general life expectancy has stagnated since WW2; that is unprecedented for peacetime. But for the lower economic classes, it’s even worse. In the UK, the life expectancy of the poor has been decreasing for a decade now. It’s no coincidence, Marmot argues, that this trend emerged in a context of harsh austerity measures. Having reduced the purchasing power of the underprivileged, healthy living is increasingly out of reach.

Other advanced economies, the US in particular, show similar trends. There, too, structural inequalities give rise to job insecurity, housing insecurity, food insecurity, racism, and violence. These disadvantages translate into worse health for the poor. So, to improve the health of the American people, a better healthcare system would only be the beginning. To actually improve public health, the US would need to address the socio-economic inequalities that underlie it.

These insights offer a fresh take on the national responses to the COVID-19 outbreak, too. Many governmental remedies are receiving criticism for ‘treating the symptom and not the cause,’ echoing Professor Marmot’s plea. On top of that, most nations’ stimulus packages do not sufficiently alleviate the economic despair of the most vulnerable groups, leading to a worsening of the socio-economic conditions that are associated with bad health. The issues Marmot points out may only accelerate during this crisis.

Marmot’s work demonstrates the interconnected nature of many of the societal challenges we study in YSI: socioeconomic inequality, societal fragmentation, the concentration of economic and political power, and ultimately human despair. As Rob Johnson commented: “We must continue trying to understand how and why the political economy produces these conditions and tolerates them.”

A recording of Professor Marmot’s webinar is available here. Marmot’s book, the Health Gap, provides a more detailed account of his findings.

Is the COVID-19 Crisis a “Mehrling’s Moment”?

Derivatives Market as the Achilles’ Heel of the Fed’s Interventions

By Elham Saeidinezhad | Some describe the global financial crisis as a “Minsky moment” when the inherent instability of credit was exposed for everyone to see. The COVID-19 turmoil, on the other hand, seems to be a “Mehrling moment” since his Money View provided us a unique framework to evaluate the Fed’s responses in action. Over the past couple of months, a new crisis, known as COVID-19, has grown up to become the most widespread shock after the 2008-09 global financial crisis. COVID-19 crisis has sparked historical reactions by the Fed. In essence, the Fed has become the creditor of the “first” resort in the financial market. These interventions evolved swiftly and encompassed several roles and tools of the Fed (Table 1). Thus, it is crucial to measure their effectiveness in stabilizing the financial market.

In most cases, economists assessed these actions by studying the change in size or composition of the Fed’s balance sheet or the extent and the kind of assets that the Fed is supporting. In a historic move, for instance, the Fed is backstopping commercial papers and municipal bonds directly. However, once we use the model of “Market-Based Credit,” proposed by Perry Mehrling, it becomes clear that these supports exclude an essential player in this system, which is derivative dealers. This exclusion might be the Achilles’ heel of the Fed’s responses to the COVID-19 crisis.

What system of central bank intervention would make sense if the COVID-19 crisis significantly crushed the market-based credit? This piece employs Perry Mehrling’s stylized model of the market-based credit system to think about this question. Table 1 classifies the Fed’s interventions based on the main actors in this model and their function. These players are investment banks, asset managers, money dealers, and derivative dealers. In this financial market, investment banks invest in capital market instruments, such as mortgage-backed securities (MBS) and other asset-backed securities (ABS). To hedge against the risks, they hold derivatives such as Interest Rate Swaps (IRS), Foreign exchange Swaps (FXS), and Credit Default Swaps (CDS). The basic idea of derivatives is to create an instrument that separates the sources of risk from the underlying assets to price (or even sell) them separately. Asset managers, which are the leading investors in this economy, hold these derivatives. Their goal is to achieve their desired risk exposure and return. From the balance sheet perspective, the investment bank is the mirror image of the asset manager in terms of both funding and risk.

This framework highlights the role of intermediaries to focus on liquidity risk. In this model, there are two different yet equally critical financial intermediaries—money dealers, such as money market mutual funds, and the derivative dealers. Money dealers provide dollar funding and set the price of liquidity in the money market. In other words, these dealers transfer the cash from the investors to finance the securities holdings of investment banks. The second intermediary is the derivative dealers. These market makers, in derivatives such as CDS, FXS, and IRS, transfer risk from the investment bank to the asset manager and set the price of risk in the process. They mobilize the risk capacity of asset managers’ capital to bear the risk in assets such as MBS.

After the COVID-19 crisis, the Fed has backstopped all these actors in the market-based credit system, except the derivative dealers (Table 1). The lack of Fed’s support for the derivatives market might be an immature decision. The modern market-based credit system is a collateralized system. To make this system work, there should be a robust mechanism for shifting both assets and the risks. The Fed has employed extensive measures to support the transfer of assets that is essential for the provision of funding liquidity. Financial participants use assets as collaterals to obtain funding liquidity by borrowing from the money dealers. During a financial crisis, however, this mechanism only works if a stable market for risk transfer accompanies it. It is the job of derivative dealers to use their balance sheets to transfer risk and make a market in derivatives. The problem is that fluctuations in the price of assets that derive the value of the derivatives expose them to the price risk.

During a crisis such as COVID-19 turmoil, the heightened price risks lead to the system-wide contraction of the credit. This occurs even if the Fed injects an unprecedented level of liquidity into the system. If the value of assets falls, the investors should make regular payments to the derivative dealers since most derivatives are mark-to-market. They make these payments using their money market deposit account or money market mutual fund (MMMFs). The derivative dealers then use this cash inflow to transfer money to the investment bank that is the ultimate holder of these instruments. In this process, the size of assets and liabilities of the global money dealer (or MMMFs) shrinks, which leads to a system-wide credit contraction.

As a result of the COVID-19 crisis, derivative dealers’ cash outflow is very likely to remain higher than their cash inflow. To manage their cash flow derivative dealers, derive the prices of the “insurance” up, and further reduce the price of capital or assets in the market. This process further worsens the initial problem of falling asset prices despite the Fed’s massive asset purchasing program. The critical point to emphasize here is that the mechanism through which the transfer of the collateral, and the provision of liquidity, happens only works if fluctuations in the value of assets are absorbed by the balance sheets of both money dealers and derivative dealers. Both dealers need continuous access to liquidity to finance their balance sheet operations.

Traditional lender of last resort is one response to these problems. In the aftermath of the COVID-19 crisis, the Fed has indeed backstopped the global money dealer, asset managers and supported continued lending to investment banking. Fed also became the dealer of last resort by supporting the asset prices and preventing the demand for additional collateral by MMMFs. However, the Fed has left derivative dealers and their liquidity needs behind. Importantly, two essential actions are missing from the Fed’s recent market interventions. First, the Fed has not provided any facility that could ease derivative dealers’ funding pressure when financing their liabilities. Second, the Fed has not done enough to prevent derivative dealers from demanding additional collaterals from asset managers and other investors, to protect their positions against the possible future losses.

The critical point is that in the market-based finance where the collateral secures funding, the market value of collateral plays a crucial role in financial stability. This market value has two components: the value of the asset and the price of underlying risks. The Fed has already embraced its dealer of last resort role partially to support the price of diverse assets such as asset-backed securities, commercial papers, and municipal. However, it has not offered any support yet for backstopping the price of derivatives. In other words, while the Fed has provided support for the cash markets, it overlooked the market liquidity in the derivatives market. The point of such intervention is not so much to eliminate the risk from the market. Instead, the goal is to prevent a liquidity spiral from destabilizing the price of assets and so, consequently, undermining their use as collateral in the market-based credit.

To sum up, shadow banking has three crucial foundations: market-based credit, global banking, and modern finance. The stability of these pillars depends on the price of collateral, price of Eurodollar, and price of derivatives, respectively. In the aftermath of the COVID-19 crisis, the Fed has backstopped the first two dimensions through tools such as the Primary Dealer Credit Facility, Term Asset-Backed Securities Loan Facility, and Central Bank Swap Lines. However, it has left the last foundation, which is the market for derivatives, unattended. According to Money View, this can be the Achilles’ heel of the Fed’s responses to the COVID-19 crisis.