Financial repression is a policy that channels cheap funding to governments, typically supported by accommodative monetary policy. After the global financial crisis various forms of financial repression have prevailed in most developed and many emerging countries. These policies have been effective in containing public debt but bear risks for future financial stability.
In a recent speech Federal Reserve Chair Yellen has emphasized the economic cost of making financial risk a key consideration of monetary policy. While accommodative and non-conventional monetary policy may boost risk taking, enhanced regulation should secure financial system resilience and contain excesses. Only when macroprudential policy cannot achieve that goal should monetary policy step in. That time would not be now.
Brunnermeier and Sannikov illustrate in a formal model why fundamental risk and asset market volatility can be out of sync. They focus on endogenous market dynamics, such as “collateral amplification” (the mutual reinforcement of credit conditions and asset values). These endogenous dynamics imply that [i] low-risk environments foster systemic risk, [ii] market reactions to negative fundamental shocks are non-linear (i.e. can become catastrophic when the shock is large) and [iii] financial market risk can de-couple from fundamental risk.
The “net stable funding ratio” is a quantitative liquidity standard for regulated banks, scheduled to go into effect in 2018. It will require stable funding sources to be equal or exceed illiquid assets. It may to some degree restrict term transformation of regulated banks and encourage migration into shadow banking. The impact of the new regulation will differ across countries and institutions.
John Coates gives a neuroscience view on how human “stress response” can aggravate financial crises. Rising market volatility causes a bodily response in form of a sustained elevation of the stress hormone cortisol in traders and investors. This raises risk aversion and may contribute to institutional paralysis. Central banks’ policies aimed at keeping markets calm in normal times may weaken traders’ immune system.
Regulators and financial institutions rely on statistical models to assess market risk. Alas, a new Federal Reserve paper shows that risk models are prone to creating confusion when they are needed most: in financial crises. Acceptable performance and convergence of risk models in normal times can lull the financial system into a false sense of reliability that transforms into model divergence and disarray when troubles arise.
The Basel III capital regulation reforms introduced a non-risk based leverage ratio for banks. A new ECB paper shows that a leverage ratio requirement may have unintended negative consequences. It encourages banks that specialize on low-risk lending to raise their share of high-risk loans. And it could make overall bank portfolios more similar, increasing the contamination risk from negative surprises to expected default risks.
An updated paper by Adam, Beutel, and Marcet claims that booms and busts in U.S. stock prices can be explained by investors’ subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market troughs.
Bank of England’s Andrew Haldane has summarized the rise and risks of asset management in a recent speech. As demographics and economic development propel the industry to ever higher assets under management, self-reinforcing correlated dynamics become a greater systemic concern. Market conventions, accounting practices, regulatory changes and structural changes in the industry all contribute to this risk.
Nomura research has summarized evidence of oversupply of residential property in China. Urban floor space per capita is now estimated to be higher than in some developed countries. Land conversion is still rising, while urbanization is slowing. Potential triggers for a sharp correction include interest rate liberalization, capital outflows and property taxes. A plunge in property activity would have serious economic and financial consequences.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
