Financial Intermediation and the International Business Cycle Discussion

Financial Intermediation and the International
Business Cycle
Discussion
Tommaso Monacelli
Università Bocconi, IGIER and CEPR
Federal Reserve Bank of NZ
Wellington, December 2010
Structure
I
IRBC model
I
Four agents
1. Households: save in the form of deposits
2. K producers: borrow from banks in order to produce new
capital
3. Goods producers: rent capital from K producers !combine
with labor ! produce goods
4. Banks: intermediate funds between households and K
producers
Modelling banks
I
Production function approach
1. Combine deposits and labor
2. Combine deposits and bank capital
Some questions
I
K producers face a borrowing constraint
= χkt +1
qt
|{z}
borrowing
1. Why are they always the borrowers?
2. Why do they want to borrow up to the limit?
Key problems
1. Could we do away with banks in this economy?
2. Presence of banks does not add much to the transmission
mechanism of shocks
I
Common to other papers in the literature (e.g., Gerali et al.
2009, Curdia an Woodford, 2009)
I
Reasons
1. Banks do not face any friction
2. Perfect international …nancial markets
Banking models with frictions
1. Classic: Holmstrom and Tirole (1999) ! Implemented in
DSGE by Meh and Moran (2010)
2. Gertler and Karadi (2010)
Source: Meh and Moran (2010)
Responses to a technology shock
Banks and the Financial Crisis
Lacks a few elements
1. "Shadow banks" and interbank/repo market
2. Maturity mismatch and liquidity problem
3. The "right" …nancial shock
Financial intermediaries
! Current crisis: key role of balance-sheet e¤ects of banks
Key element in the crisis
I
Liquidity problem for "new" …nancial intermediaries
traditional banks
"investment" banks
Assets
long-term loans
MBS
Liabilities
deposits
short-term debt
Boom of securitized products
I
Used as collateral in interbank/repo markets
Fraction of AAA rated securities
securitized products
60%
corporate bonds
1%
(source Fitch, 2007)
Gigantic maturity mismatch
I
Banks held long-term assets (e.g., MBS) …nanced via
short-term debt (e.g., commercial paper)
I
When things deteriorate it is the liquidity problem that
matters
The role of securitization
I
Diversi…es idiosyncratic risk, but increases sensitivity to
aggregate risk
The magic of securitization
Coval, Jurek, and Sta¤ord (2010)
I
I
Suppose two identical bonds, each with probability of NOT
default = 0.9 ! prob. default = 1 0.9 = 0.1
NB: prob. default uncorrelated
I
Combine them in a CDO (collateralized debt obligation)
1. Junior tranche: pay if both tranches do not default
2. Senior tranche: defaults only if both default
junior
PAY
0.92 = 0.81
DEFAULT
1 0.81 = 0.19
senior
0.99
(1
0.9)2 = 0.01
I
Result: credit enhancement for the senior tranche
I
"Side e¤ect": tranches become correlated even if underlying
assets are not
Dynamics of crisis
Bad shock (what is this? )
=)Financial conditions deteriorate
=)Lenders reduce exposure !Ask to service debt
=)Banks try to …re sale long-term illiquid assets
Liquidity friction
I
At least as crucial as borrowing friction
I
Is it "…re-sale per se" or is it "…re sale" of long-term illiquid
assets"?
! Requires modelling of:
(i) Interbank market
(ii) Maturity of assets
Sketch of a model with two ingredients
I
"Banks sudden stop"
I
Shock to haircut margins
Agents
I
Savers
cs ,t +
dt = rtd 1 dt
|{z}
1
+ wt
deposits
I
Entrepreneurs
ce,t + qt (ke,t
ke,t
1) +
rtl (m )lt (m )
|
1 m l
rt
m k∑
=1
(1
k (m )lt k (m )
χ)Et fke,t +m
{z
collateral constraint
=
lt (m )
| {z }
long-term loans
1 qt +m g
}
+yt
Banks
I
Commercial banks
bt + Φ(bt ) = dt
Banks (con’t)
I
Investment banks
V (bt
1 , lt k , γt )
= max [xt + βx Et fV (bt , lt , γt +1 )g]
xt = bt +
1 m l
rt
m k∑
=1
xt ,b t ,lt
k (m )lt k (m )
lt (m )
s.t. haircut constraint:
rtb bt
|{z}
short-term borrowing
I
(1 γt ) lt (m)
| {z }
haircut shock
Banks’sudden stop: haircut constraint becomes
(endogenously) binding