Wednesday, July 1, 2009

Update on the Period of Financial Distress and a Bubble Mystery

Nearly a year ago (7/12/08) I posted here on "Falling from the Period of Financial Distress into Panic and Crash". In that I noted my own work on this concept, which Charles Kindleberger claimed in his Manias, Panics, and Crashes has been the most common pattern of speculative bubbles and crashes (37 out of 47 bubbles listed in Appendix B of his 2000 4th edition). What is involved is for there to be a gradual decline in prices initially after the peak of a bubble, with the crash coming sometime later. The paper I cited then on this by Mauro Gallegati, Antonio Palestrini, and me ("The period of financial distress in speculative markets: interacting heterogeneous agents and financial constraints," available on my website), has now been accepted for publication and is forthcoming in Macroeconomic Dynamics.

The three patterns that Kindleberger, drawing on the work of Hyman Minsky, argued we have generally seen are ones with such a period of distress as described above, ones that go up to a peak and then crash hard (which are what most theoretical models of crashes predict), and ones that go up to a peak and then decline gradually without a crash, but usually a bit faster than they went up. In the last few years I would argue we have seen all three patterns. The peak-followed-by-crash pattern looks like the oil market last year, which hit $147 per barrel last July only to fall hard to $32 per barrel by November. The more or less symmetric up-then-down-without a crash pattern looks like the US housing market, which, according to the Case-Shiller index, began rising in 1998, peaked in mid-2006, and has been going down since about the way it went up, with quite a ways to go.



Last year I had it in my mind that the global financial derivatives market smelled like a period of financial distress pattern, and now I think that it was indeed. The peak was in August 2007, when the problems in those markets first began to appear. The crash was the dramatic "Minsky moment" in mid-September 2008.

Which brings me to a fourth pattern that is somewhat mysterious, a variation on the pattern that does not have a crash. Whereas most such bubbles go down more rapidly than they went up, and some go down at about the same rate, there is one that has gone down at a much slower rate, indeed may still be in its decline. I am referring to housing in Japan. A graph of the pattern up to 2005 can be seen at http://en.wikipedia.org/wiki/File:EconomistHomePrices20050615.jpg. Around 2006 there was a brief cessation of the decline, but it has since resumed. In any case, that figure shows that the index rose in three years from 150 to its peak around 200, but took ten years thereafter to get back to 150, and it took 15 years from the peak in 1991 to get back down to the level it was in 1986, a clear asymmetry in the direction of going up much faster than it has gone down.

Now, according to private communication from Kindlebeger to me, this is the only major bubble in world history to exhibit such a pattern, and why it has done so remains a mystery. I saw a paper (still unpublished) some years ago that argued that it was Japanese banks manipulating the real estate market to keep the value of their most important collateral from declining too rapidly in the face of broader financial pressure that have been behind this pattern, but I have not seen that confirmed. That would suggest that the pattern has had deep implications for the broader Japanese economy. In any case, this curious decline in Japan remains a mystery (and some say that US housing prices could go down for a much longer time than many think, pointing to this strange case), but it may ultimately have to do with the Japanese wishing to preserve their broader economic system in the face of pressures to more deeply transform it.

10 comments:

Ken Houghton said...

Japanese banks artificially inflated both the RE and stock markets for years with easy money. The hiss took 5-7 years instead of a puncture; otoh, the damage was extended and the failures were probably, on balance, a better mix than a quick explosion would have been.

On a social welfare basis, there's a legitimate argument that Japan did the right thing.

Economist said...

Janet Yellen, President of the San Francisco Federal Reserve, pointed out at the 18th annual conference honoring the work of Hyman P. Minsky that:

"... with the financial world in turmoil, Minsky’s work has become required reading. It is getting the recognition it richly deserves."


Paul Krugman has also been re-reading Hyman Minsky’s most famous book Stabilizing an Unstable Economy.

Central to Minsky’s view of how financial meltdowns occur is his Financial Instability Hypothesis (FIH) -- what has come to be known as 'an investment theory of the business cycle and a financial theory of investment'. But, what is it all about? Quoting from Minsky . . .

Read more here:
http://neweconomicperspectives.blogspot.com/2009/06/financial-instability-hypothesis.html

Brenda Rosser said...

There seem to be a number of things happening in this era that are unique to world history. They seem to point to the possibility of unusual behaviour in 'markets'.

The dominance of the transnational corporations and their interlocking directorates and ownership. Along with their intracorporate (non-market) trading across international boundaries.

The use of these TNCs by developed (mostly western) national governments to engage in imperialistic grabs for resources and markets with the support of the military. Other economic warfare techniques.

The new compulsion for workers to devote a greater and greater percentage of their salaries to 'investment' in these TNCs, in order to pay for their retirement pensions.

The Full Spectrum Dominance of the US over the world economy.

1966 Onwards. Domestic monetary policy invalidated for large corporations and banks because the Euromarket and non-banking institutions provided an uncontrolled source of global funds. ... Large scale defaults became dangerous business. Central banks unwilling to impose controls on banks portfolios.

The dramatic and unprecedented rise in urbanisation across the globe.

Mumford described a new reality based on centralization, control and efficiency.

Shag from Brookline said...

Brenda:

"The use of these TNCs by developed (mostly western) national governments to engage in imperialistic grabs for resources and markets with the support of the military. Other economic warfare techniques."

GE's president Jeff Immelt was on Charlie Rose recently talking up how he is stressing GE refocusing upon its US business, in particular to reinvigorate the manufacturing sector in the US, even though much of GE's business is international. Apparently GE has its cake and wants to eat it too what with its special financial bailouts even though GE Credit is not regulated as a bank. I think Immelt was aiming at potential investors in GE stock. (This appearance was prior to the public disclosure of GE Credit gaming the bailout funding.)

Brenda Rosser said...

Shag, Here's some interesting history, GE-related, from the early to late 1990s:

"The presumed market efficiency of giant merged firms trumps fears of diminished competition. The new perspective focuses more exclusively on the purely economic effects of mergers and monopolies, without considering the political and social consequences of giant firms with giant market shares. Even Joel Klein, prosecuting the Justice Department's antitrust case against Microsoft, says, "I really view our mission as market driven," meaning that he is not concerned about monopoly per se but about preserving whatever market arrangements sustains "innovation" and "economic efficiencies" [29]

.....While the GLOBAL market share of American-based firms has declined in some industries such as auto and steel, oligopolistic dominance - as reflected in the percentage of market share controlled by the largest American, European and Asian firms - has remained extraordinarily high. In many cases, market share by the top firms has actually increased in both global and American market sectors. By the early 1990s, five firms controlled more than 50 percent of global market share in consumer durables, steel, aerospace, electronic components, airline, and auto industries. In oil, personal computers, and media, five firms controlled more than 40 percent of the market. In American markets ranging from commercial airlines and aerospace to computer hardware and software to household appliances, three or four firms control up to 90 percent of the market, and market share concentration continues to increase through mergers and targeted growth strategies. [30]

GE's CEO Jack Welch's dictum is that "if any of his far-flung divisions was not No 1, 2 or 3 in their markets he would sell them." According to Harvard Business School's Michael Porter, the new economy may be making even Welch's version obsolete: "Even No 3 in any market segment can no longer be assured of survival." Information Age industries require enormous capital for front-end fixed cost investment, as well as for global production and marketing. with their deep ockets, the leading corporations have moved aggressively to specialise in market segments they can dominate, shaping a global economy of virtually monopolised market niches, from microscopic semiconductors to side-body jet engines. Each of the top thirty companies is a mosaic of hundreds of specialised monopolies or duopolies knot together in a single corporate game plan. [31]

[29] Joel Klein quoted in Labaton, "Bill Gates", p 7. For a review of antitrust movement and policy historically, see Rudolph JR Pertitz, 'Competition Policy in America' 1888-1992 (New York: Oxford Uni Press, 1996). See also Roger D Blair and Jeffrey L Harrison, 'Monoposony: Antitrust Law and Economics' (Princeton Uni Press 1993). See also Thomas Karier, 'Beyond Competition: The Economics of Merges and Monopoly Power' (Armonk NY; ME sharpe, 1993). Also Kurt Rudolf Minow and Harry Maurer, 'Webs of Power: International Cartels and the World Economy' (Boston: Houghton Mifflin, 1982).

[30]Several different business reference volumes document changing market share concentrations in each major industry. See especially 'Market Share Reporter' (Detroit, MI: Gale Research, 1998). See also Korten, 'Corporations Rule' p23.

[31] Steven Pearlstein, 'Washington Post Weekly', December 11-17, 1996.

'Corporation Nation' by Charles Derber. 1998. ISBN 0-312-19288-6. Pages 59- 62 Chapter three:'The Mouse, Mickey Mouse, and Baby Bells'

Brenda Rosser said...

and more recently:

2009 – January 20th. GE’s share price dives from about $35/share in March 2008 to $12.93 today.

Mideast Widens Aircraft Ventures. As Airbus, Boeing Co. and General Electric Co. struggle with soaring oil prices, slowing economies and squeezed delivery dates, multibillion-dollar aircraft orders from airlines in Abu Dhabi and Dubai, in the United Arab Emirates, provide much-needed investment, cheap labor and state-of-the-art facilities. But the governments in the Gulf region expect something in return… (Wall Street Journal)

jm said...

One factor reported in the Japanese business press about a decade ago as slowing the price decline was that people inheriting real estate were finding that due to the lag in decline of values being assessed for tax purposes it made no sense for them to pay the taxes, and that the only course open to them was to let the government confiscate the property.

So the government was coming into possession of large amounts of real estate which it did not wish to sell at market-clearing prices that would have collapsed the nominal price structure. As this also kept assessed values far above market-clearing prices, it ensured that the practice of deeding inherited property over to the government in lieu of tax payment would continue.

At the same time, many zombie companies were being kept from dissolution through the zero-interest-rate policy, and this presumably kept the land they owned off the market.

So the market prices were not market-clearing prices, but rather the prices which a small number of purchasers were willing and able to pay.

One sees a similar situation now in the NW suburbs of Chicago. In suburbs for which the MLS lists 100+ homes at prices above $600k, dozens above $1 million, only five or six homes will have sold so far this year in that price range. Many of the homes have been on the market for two years or more, but their owners refuse to lower their asking prices to market-clearing levels, so the apparent price level fall as measured by the Case-Shiller methodology of measuring changes in prices at which individual homes are resold fails to reveal the true state of the market.

Anonymous said...

What about the Austrlaian housing bubble. When it burst it continued to go up! Explain that.

Brenda Rosser said...

The Australian housing prices are being sustained by changes to foreign investment rules made by the Rudd (neoliberal) government.

Asian residents with temporary visas can now buy housing here.

This is causing big problems in the city of Melbourne because teachers and other key workers cannot afford the housing there.

Actually my husband was offered what used to be regarded as a well-paid job in Sydney but we opted out. The rental charges are so extraordinarily high there that the extra income was insufficient to make the move worthwhile. (In our case, compensation would also be needed to be persuaded to deal with the awful city traffic and air pollution. Not that Tasmania is paradise on earth anymore!)

Shag from Brookline said...

"What about the Austrlaian housing bubble. When it burst it continued to go up! Explain that."

Down under gentrification?