APRIL 2 2010

Alan Greenspan, Brookings: The Crisis. The bubble started to unravel in the summer of 2007. But unlike the debt-lite deflation of the earlier dotcom boom, heavy leveraging set off serial defaults, culminating in what is likely to be viewed as the most virulent financial crisis ever. The major failure of both private risk management and official regulation was to significantly misjudge the size of tail risks that were exposed in the aftermath of the Lehman default. Had capital and liquidity provisions to absorb losses been significantly higher going into the crisis, contagious defaults surely would have been far less. This paper argues accordingly that the primary imperative going forward has to be (1) increased regulatory capital and liquidity requirements on banks and (2) significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades.

S. Pelin Berkmen et al, VoxEU: The global financial crisis: Why were some countries hit harder? Despite the global reach of the financial crisis, some countries fared better than others. This column argues that this was due to differences in trade or financial openness, underlying vulnerabilities to external forces, or the strength of their economic policies. The evidence suggests drawing some – preliminary – policy lessons: Exchange-rate flexibility is crucial to dampen the impact of large shocks. Prudential regulation and supervision need to focus on preventing the build-up of vulnerabilities that are particularly associated with credit booms, such as excessive bank leverage. A solid fiscal position during “good times” creates some buffers to conduct countercyclical fiscal policies during shocks.

Steven B. Kamin, Laurie Pounder DeMarco, Fed: How Did a Domestic Housing Slump Turn into a Global Financial Crisis? Was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? To answer this question, we assessed whether countries that held large amounts of U.S. mortgage-backed securities (MBS) and were highly dependent on dollar funding experienced a greater degree of financial distress during the crisis. We found little evidence of such “direct contagion” from the United States to abroad. Although CDS spreads generally rose higher and bank stocks generally fell lower in countries with more exposure to U.S. MBS and greater dollar funding needs, these correlations were not robust, and they fail to explain the lion’s share of the deterioration in asset prices that took place during the crisis. Accordingly, channels of “indirect contagion” may have played a more important role in the global spread of the crisis: a generalized run on global financial institutions, given the opacity of their balance sheets; excessive dependence on short-term funding; vicious cycles of mark-to-market losses driving fire sales of MBS; the realization that financial firms around the world were pursuing similar (flawed) business models; and global swings in risk aversion. The U.S. subprime crisis, rather than being a fundamental driver of the global crisis, may have been merely a trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world.

Lucian Bebchuk, Alma Cohen, Holger Spamann, Project Syndicate: Paid to Fail. After Bear Stearns and Lehman Brothers melted down, ushering in a worldwide crisis, media reports largely assumed that the wealth of these firms’ executives was wiped out, together with that of the firms they navigated into disaster. This “standard narrative” led commentators to downplay the role of flawed compensation arrangements and the importance of reforming the structures of executive pay. In our study, “The Wages of Failure: Executive Compensation at Bear Stearns and Lehman Brothers 2000-2008,” we examine this standard narrative and find it to be incorrect. We piece together the cash flows derived by the firms’ top five executives using data from Securities and Exchange Commission filings. We find that, notwithstanding the 2008 collapse of the firms, the bottom lines of those executives for the period 2000-2008 were positive and substantial.

N. Gregory Mankiw, NYT: Trying to Tame the Unknowable. THE economy is recovering, in baby steps, from the financial crisis and deep recession of 2008 and 2009.What can policy makers do to prevent this kind of thing from happening again? One thing we cannot do very well is forecast the economy. Another thing we cannot do very well is regulate financial institutions. So where does this leave us? We should certainly aim for better financial regulation, especially for institutions with government-insured deposits. More transparency and more accurate assessment of risks are admirable goals. Higher capital requirements would be a step in the right direction. Whatever we do, let’s not be overoptimistic. We should plan for future financial crises, to occur at some unknown date for some unknown reason, and arm ourselves with better tools to clean up the mess. My favorite proposal is to require banks, and perhaps a broad class of financial institutions, to sell contingent debt that can be converted to equity when a regulator deems that these institutions have insufficient capital.

David Brooks, NYT: The Return of History. Economics achieved coherence as a science by amputating most of human nature. Now economists are starting with those parts of emotional life that they can count and model (the activities that make them economists). But once they’re in this terrain, they’ll surely find that the processes that make up the inner life are not amenable to the methodologies of social science. The moral and social yearnings of fully realized human beings are not reducible to universal laws and cannot be studied like physics. Once this is accepted, economics would again become a subsection of history and moral philosophy. Economics will be realistic, but it will be an art, not a science.

Joshua Angrist, Jörn-Steffen Pischke, NBER: The Credibility Revolution In Empirical Economics: How Better Research Design Is Taking The Con Out Of Econometrics. This essay reviews progress in empirical economics since Leamer’s (1983) critique. As we see it, the credibility revolution in empirical work can be traced

to the rise of a design-based approach that emphasizes the identification of causal effects. Design-based studies typically feature either real or natural experiments and are distinguished by their prima facie credibility and by the attention investigators devote to making the case for a causal interpretation of the findings their designs generate. Design-based studies are most often found in the microeconomic fields of Development, Education, Environment, Labor, Health, and Public Finance, but are still rare in Industrial Organization and Macroeconomics. We explain why IO and Macro would do well to embrace a design-based approach. Finally, we respond to the charge that the design-based revolution has overreached.

Jan C. van Ours, Lenny Stoeldraijer Age, CESIfo: Wage and Productivity.

Previous empirical studies on the effect of age on productivity and wages find contradicting results. Some studies find that if workers grow older there is an increasing gap between productivity and wages, i.e. wages increase with age while productivity does not or does not increase at the same pace. However, other studies find no evidence of such an age related pay productivity gap. We perform an analysis of the relationship between age, wage and productivity using a matched worker-firm panel dataset from Dutch manufacturing covering the period 2000-2005. We find little evidence of an age related pay-productivity gap.

Carl Gaigné et al, INRA-ESR: Are compact cities environmentally friendly? The concentration of activities decreases the ecological footprint stemming from commodity shipping between cities, but it increases emissions of greenhouse gas by inducing longer worktrips. What matters for the ecological footprint of cities is the mix between urban density and the global pattern of activities. As expected, when both the intercity and intraurban distributions of activities are given, a higher urban density makes cities more environmentally friendly and raises global welfare. However, once we account for the fact that cities may be either monocentric or polycentric as well as for the relocation of activities between cities, the relationship between density and the ecological footprints appears to be much more involved. Indeed, because changes in urban density affect land rents and wages, firms are incited to relocate, thus leading to new commuting patterns. We show policies that favor the decentralization of jobs in big cities may reduce global pollution and improve global welfare.