Financial Markets and Financial Crises.

Kindleberger, Charles P.

This book which grew out of a 1990 NBER conference divides fairly well into two parts, the first on crises and panics in commercial banking, the second on current issues in corporate debt, the dollar and the savings-and-loan troubles of the 1980s.

The first part include papers by Mark Gertler, Glenn Hubbard and Anil Kashyap on the connections between crises and fluctuations in real investment; by Ben Bernanke and Harold James on the gold standard and 1929; by Fred Mishkin, testing the role of asymmetric information in panics; and by Charles Calomoris and Gary Gorton on the origins of panics. Barry Eichengreen and Peter Garber also write on the 1951 Fed-Treasury accord, an issue on the edge of the crisis theme.

There is much to chew on in these initial essays. The writers are at pains to move beyond earlier views focussed narrowly on monetary explanations, for example, that the October crash had little to do with the 1929-33 depression, or that distinction should be made between "real" financial crises which involved large declines in the money base, and "pseudo crises" which confound markets but do not. Much is what is made of what are claimed to be new theoretical insights, some of which are familiar if put into plain English from the new jargon, e.g., asymmetric information, adverse selection, moral hazard, agency problems, heterogenously-informed depositors, sequential-service constraint. Emphasis is put on panics occuring following a rise in the interest-rate differential between riskless and risky assets, following some untoward event such as a stock-market crash. Today in Wall Street this is called "a flight to quality." It is consonant with a change in expectations from euphoric which may have resulted in a bubble or in less spectacular overshooting to uncertainty or to fears of trouble.

Little attention is given to the events causing the change in expectations. Gertler, Hubbard and Kashyap blame monetary policy, mentioned three times in a single paragraph [p. 27]. Bernanke and James mention the possibility of a rise in real wages, without noting that this in 1929 and later came entirely from the decline in prices. Bernanke's frequently-cited 1983 paper explaining how bank troubles could produce depression through credit rationing did not investigate the connection between call-loan difficulties in October 1929 and the collapse in commodity prices as bank credit was denied commodity brokers. His paper with James mentions a price decline of 4 percent in 1929. With monthly instead of annual data, this decline, concentrated mostly into two months, when U.S. nominal imports fell 25 percent, would look different. Nor do Bernanke and James observe that the depreciation of sterling involved appreciation of the gold bloc and the dollar, with strong downward pressure on prices, another force supporting the debt-deflation argument of Fisher, Minsky and Kindleberger, which they allow as a possibility but for which they do not test.

Mishkin's emphasis on the interest differential makes a powerful case. in his further research he might note that in 1930, it occurred in foreign bonds (March) earlier than in domestic issues [5, 227; 2, 304]. It went beyond bonds, treasury bills and commercial paper, moreover, into municipal bonds [4] to mortgages (the Bank of the United States) and to real estate [3].

Calomoris and Gorton, investigating the origin of panics, compare "random withdrawals," especially at harvest or planting time when agricultural credit is stretched, with asymmetric information, and decide, after some hesitation, in favor of the latter. They divide depositors into insiders and outsiders, the sophisticated and the badly informed, a distinction that could also be made in the euphoric phase of booms, applauding the well-informed who withdraw deposits early for their help in monitoring banks [p. 126]. Would that also apply to those who break early for the doors in a theatre when someone has shouted fire? What is rational in an individual may be dysfunctional en masse.

Mark Warshawsky's paper on corporate debt concludes that there is still considerable danger in high debt structures, especially in construction. The data in his, as in most of the papers reach down only to 1988, and cannot assess the relief afforded by the 1991 reduction in interest rates. Bankim Chadha and Steven Symansky apply the IMF MULTIMOD econometric model to the single years from 1990 to 1995 and to 2000 and 2010, with various assumptions, to contemplate whether the U.S. balance of payments is sustainable. Besides the U.S., there is a group of other industrial countries, which lend, and the net debtor countries, which take little part in the action. I have little faith in linear models which stretch out twenty years into the future. If other countries continue to lend, and we devalue 10 percent, this country will accumulate $3.4 trillion in foreign assets by 2010. Various other assumptions, however, put the country in that year into foreign debt (all figures relative to the base line) between $1.5 and 8.4 trillion, with domestic debt, at the peak, of $32.2 trillion, owing to the power of compound interest. The authors are aware of the capital needs of Eastern Europe and the former Soviet republics, but could not allow for them.

The three papers on the thrift industry will appeal to students of finance. All emphasize the disintermediation that came with the sharp rise in interest rates in 1979-81. Patric Hendershott and James Shilling continue to worry over the possibility of new cycles of rising interest rates, given the switch from fixed to adjustable rate mortgages which helps borrowers as rates rise, even while fixed-rate borrowers refinance on the down side. Eduardo Schwartz and Walter Touros offer a technical paper on the value of caps to ARM borrowers. To this reader the long paper by George Benston, Mike Carhill and Brian Olasov was highly informative, both for the problems for thrifts from disintermediation and legislative attempts to remedy them. Studying particularly events in the southeast of the country, the authors are inclined to play down the malfeasance that features so prominently in the press. One ironic twist is that small rural thrifts whose depositors were too unsophisticated to disintermediate (and their officials too traditional to take risks, go for brokered deposits, or understand junk bonds?), survived far better than their urban counterparts.

The essays provide an abundance of data in tables and graphs, plus much econometric testing. A number of the authors, however, are less than confident about the results and call for more and careful research [pp. 27, 64, 77, 105]. It is something of a reflection on the profession that now, sixty years after the event, it is still unable to explain with confidence the 1929 U.S. and world depression.

References

[1.] Bernanke, Ben, "Non-monetary Effects of the Financial Crisis in the Propagation of the Great Depression." American Economic Review, June 1983, 257-76. [2.] Friedman, Milton and Anna Jacobson Schwartz. A Monetary History of the United States, 1867-1960. Princeton, N.J.: Princeton University Press, 1963. [3.] Hoyt, Homer. One Hundred Years of Land Values in Chicago. Chicago: University of Chicago Press, 1933. [4.] McFerrin, John Berry. Caldwell and Company: A Southern Financial Empire. Chapel Hill, N.C.: University of North Carolina Press, 1939, reissued, Nashville, Tenn.: Vanderbilt University Press, 1969. [5.] Sachs, Jeffrey. "LDC Debt in the 1980s, Risk and Reforms," in Crises in the Economic and Financial Structure, edited by Paul Wachtel. Lexington, Mass.: D.C. Heath, 1982, pp. 197-243.