Liberty Street Economics
Look for our next post on May 5, following the FOMC meeting.
March 27, 2014

The Growth of Murky Finance

Samuel Antill, David Hou, and Asani Sarkar

This post is the fifth in a series of thirteen Liberty Street Economics posts on Large and Complex Banks. For more on this topic, see this special issue of the Economic Policy Review.

Building upon previous posts in this series that discussed individual banks, we examine the historical growth of the entire financial sector, relative to the rest of the economy. This sector’s historically large share of the economy today (see chart below) and its role in disrupting the functioning of the real economy during the recent financial crisis have led to questions about the social value of costly financial services. While new regulations such as the Dodd-Frank Act impose restrictions on financial activities and increase their costs, especially those of large firms, our paper  suggests that there may be limits to what regulation can achieve. In particular, we show that financial growth has occurred in the more opaque and harder to regulate sectors: private firms, shadow banks, and small nonbank financial firms. Moreover, we find that the stock market values these opaque areas of finance more, suggesting that they may expand even faster in the future.

March 26, 2014

Do “Too-Big-to-Fail” Banks Take On More Risk?

Gara Afonso, João Santos, and James Traina

This post is the fourth in a series of thirteen Liberty Street Economics posts on Large and Complex Banks. For more on this topic, see this special issue of the Economic Policy Review.

In the previous post, João Santos showed that the largest banks benefit from a bigger discount in the bond market relative to the largest nonbank financial and nonfinancial issuers. Today’s post approaches a complementary Too-Big-to-Fail (TBTF) question—do banks take on more risk if they’re likely to receive government support? Historically, commentators have expressed concerns that TBTF status encourages banks to engage in risky behavior. However, empirical evidence to substantiate these concerns thus far has been sparse. Using new ratings from Fitch, we tackle this question by examining how changes in the perceived likelihood of government support affect bank lending policies.

Posted by Blog Author at 7:02 AM in Financial Institutions | Permalink | Comments ( 5 )

Evidence from the Bond Market on Banks’ “Too-Big-to-Fail” Subsidy

João A. C. Santos

This post is the third in a series of thirteen Liberty Street Economics posts on Large and Complex Banks. For more on this topic, see this special issue of the Economic Policy Review.

Yesterday’s post presented evidence on a possible upside of very large banks, namely, lower costs. In today’s post, we focus on a possible downside, that is, whether investors in the primary bond market “discount” risk when they invest in bonds of the too-big-to-fail banks.

Posted by Blog Author at 7:00 AM in Financial Institutions | Permalink | Comments ( 3 )

March 25, 2014

Do Big Banks Have Lower Operating Costs?

Anna Kovner, James Vickery, and Lily Zhou

This post is the second in a series of thirteen Liberty Street Economics posts on Large and Complex Banks. For more on this topic, see this special issue of the Economic Policy Review.

Despite recent financial reforms, there is still widespread concern that large banking firms remain “too big to fail.” As a solution, some reformers advocate capping the size of the largest banking firms. One consideration, however, is that while early literature found limited evidence for economies of scale, recent academic research has found evidence of scale economies in banking, even for the largest banking firms, implying that such caps could impose real costs on the economy. In our contribution to the volume on large and complex banks, we extend this line of research by studying the relationship between bank holding company (BHC) size and components of noninterest expense, in order to shed light on the sources of the scale economies identified in previous literature.


Introducing a Series on Large and Complex Banks

Donald P. Morgan

This post is the first in a series of thirteen Liberty Street Economics posts on Large and Complex Banks. For more on this topic, see this special issue of the Economic Policy Review.

The chorus of criticism levied against mega-banks has, in some cases, outrun the research needed to back the criticism. To help the research catch up with the rhetoric, financial economists here at the New York Fed have engaged in a systematic study of the economics of large and complex banks and their resolution in the event of failure. The result of those efforts is a collection of eleven papers, each of which was subject to review (internal and external). The papers are now online in our Economic Policy Review. Today, we begin a two-week series of posts that present the key findings of each paper. Here, I’ll give a taste of each and some of the essential points delivered by them.

Posted by Blog Author at 12:00 PM in Financial Institutions | Permalink | Comments ( 1 )

March 24, 2014

Convexity Event Risks in a Rising Interest Rate Environment

Allan M. Malz, Ernst Schaumburg, Roman Shimonov, and Andreas Strzodka

The rise in the ten-year Treasury rate last summer was perhaps the most dramatic since the 2003 bond market sell-off. This post explains how major changes in the composition of agency mortgage-backed securities (MBS) ownership caused by the large-scale asset purchase programs (LSAPs) may have prevented a major convexity event triggered by MBS duration extension hedging. In fact, MBS hedging activity remained muted by historic standards and likely contributed only modestly to the rise in interest rates.


Posted by Blog Author at 7:00 AM in Financial Markets | Permalink | Comments ( 1 )

March 10, 2014

Has Automated Trading Promoted Efficiency in the FX Spot Market?

Ernst Schaumburg

The relative merits of algorithmic and high-frequency trading are most often discussed in the context of equity markets. In this post, we look at the foreign exchange (FX) spot market. The growth of algorithmic and high-frequency trading in this market has introduced new entrants as well as new complexities and challenges that have important implications for the liquidity landscape and the risk management framework in FX markets. This post focuses narrowly on an important measure of FX market efficiency, absence of arbitrage opportunities, to discuss the improvements in this particular measure of efficiency that have coincided with significant growth in algorithmic and high-frequency trading.

Posted by Blog Author at 7:05 AM in Financial Markets | Permalink | Comments ( 1 )

Just Released: Beyond the Unemployment Rate: Eight Different Faces of the Labor Market

Samuel Kapon and Ayşegül Şahin

This morning, the New York Fed released a new set of charts measuring various dimensions of the labor market. These charts are mostly generated from data available through the Current Population Survey (CPS), the Current Employment Statistics (CES) program, and the Job Openings and Labor Turnover Survey (JOLTS). This new monthly release will provide timely updates to help economists and the public understand national labor market conditions. The charts are split into eight distinct categories: unemployment, employment, hours, labor demand, job availability, job loss rate, wages, and mismatch.

Posted by Blog Author at 7:00 AM in Labor Economics | Permalink | Comments ( 3 )

March 07, 2014

Crisis Chronicles: The Credit and Commercial Crisis of 1772

James Narron and David Skeie

During the decade prior to 1772, Britain made the most of an expansion in colonial lands that required significant capital investment across the East and West Indies and North America. As commodities like tobacco flowed from colonial lands to Britain, merchandise and basic supplies flowed back to the colonies. With capital scarce in the American colonies, colonial planters were eager to borrow cheap capital from British creditors. But because planters often maintained open lines of credit through multiple trade channels, creditors had no way of knowing a particular planter’s indebtedness. So when two banks in London failed, contagion spread and the credit boom suddenly ended. In this edition of Crisis Chronicles, we learn the perils of private indebtedness and offer an inverse comparison of today’s “originate-to-distribute” mortgage market.

Posted by Blog Author at 7:00 AM in Crisis Chronicles | Permalink | Comments ( 0 )

March 05, 2014

Just Released: Harsh Winter Weather Hampers Economic Activity in the Region

Jaison R. Abel and Jason Bram

The New York Fed’s latest Beige Book report indicates that harsh winter weather hampered economic activity in the region in early 2014.

     Eight times a year, each of the nation’s twelve Federal Reserve Banks produces a report on current economic conditions in its District, based largely on anecdotal information obtained from regional business contacts. The New York Fed’s report covers New York State, northern New Jersey, and southwestern Connecticut. The twelve District reports are combined with a national summary to produce what’s come to be known as the Beige Book—a report that provides some of the most timely information available on economic conditions.
Posted by Blog Author at 2:05 PM in Regional Analysis | Permalink | Comments ( 0 )

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