[OPE] Bezemer articles

Lending must support the real economy
By Dirk Bezemer
FT November 4 2009

(...) In the 1980-2007 era of cheap credit and deregulation, banks had every
incentive to move from real-economy projects, yielding a profit, towards
lending against rising asset prices, yielding a capital gain. In the 1990s
and 2000s, loan volumes rose to unprecedented levels, supporting global
assets booms in property, derivatives and the carry trade. The share of
lending by US banks to the US financial sector - instead of to the real
economy - went from 60 per cent of the outstanding loan stock in 1980 (up
from 50 per cent in the 1950s) to more than 80 per cent in 2007.

But the price was growing indebtedness. Profit and capital gains may look
much the same to the individual bank - a stream of revenues - but they have
different macroeconomic consequences. Lending to the real sector is
self-amortising: it creates a debt, but also the value-added to repay
principal and interest. Such loans enlarge the economy in proportion to the
debts created and are financially sustainable. By contrast, loans to create
or buy financial assets and instruments are not, by themselves,
self-amortizing. In a credit boom, successive owners may sell the asset at a
profit, but their buyers will have to shoulder proportionally more debt in
order to acquire the asset, balanced (for the time being) by the asset's
value. Asset trading may be individually profitable; but it is a zero sum
game, sustainable only if the real economy furnishes enough money to support
the rising debt burden. Beyond a point, the lure of capital gains diverts
funds from real-sector investment, and households' rising debt-service cuts
demand for real-sector output. In both ways, excessive growth of financial
asset markets is self-defeating.

This logic may be traced in the statistics (all figures from the Bureau of
Economic Analysis). The US stock of loans to the real sector (as a
proportion of gross domestic product) has remained roughly constant since
the 1980s. In contrast, loans by US banks to other US banks have grown from
2.5 times GDP in 1980 to a factor of 5.8 in 2007 - all attributable to
growth in loans to the financial sector. The US financial sector was over
three times larger in 2007 compared with 1980.

Credit flowing into asset markets created a debt overhead while the real
economy's capacity to pay the debt declined. Demand for the real sector's
output also suffered as US households by 2007 were paying over a fifth of
their after-tax, disposable income to the financial sector in debt servicing
and financial fees. The US had become an economy trying to drive with the
brakes on. The real-sector recession, after the 2007 financial crisis,
occurred because the real economy had become overly dependent on continued
lending against rising asset values. Those are the trends that financial
reforms must curb. (...)

Complete article
http://www.ft.com/cms/s/0/547d2fd8-c977-11de-a071-00144feabdc0.html?nclick_check=1

Why some economists could see the crisis coming
By Dirk Bezemer
FT September 7 2009

(...) I undertook a study of the models used by those who did see it
coming.* (...) How did they do it?

Central to the contrarians' thinking is an accounting of financial flows (of
credit, interest, profit and wages) and stocks (debt and wealth) in the
economy, as well as a sharp distinction between the real economy and the
financial sector (including property). In these "flow-of-funds" models,
liquidity generated in the financial sector flows to companies, households
and the government as they borrow. This may facilitate fixed-capital
investment, production and consumption, but also asset-price inflation and
debt growth. Liquidity returns to the financial sector as investment or in
debt service and fees.
It follows that there is a trade-off in the use of credit, so that financial
investment may crowd out the financing of production. A second key insight
is that, since the economy's assets and liabilities must balance, growing
financial asset markets find their counterpart in a growing debt burden.
They also swell payment flows of debt service and financial fees.
Flow-of-funds models quantify the sustainability of the debt burden and the
financial sector's drain on the real economy. This allows their users to
foresee when finance's relation to the real economy turns from supportive to
extractive, and when a breaking point will be reached.

(...) Policymakers have resisted inclusion of balance sheets and the flow of
funds in their models by arguing that bubbles cannot be easily identified,
nor their effects reliably anticipated. The above analysts have shown that
this is, in fact, feasible, and indeed essential if we are to "see it
 coming" next time. The financial sector is just as real as the real
economy. Our policymakers, and the analysts they rely on, ignore balance
sheets and the flow of funds at their peril - and ours.

Complete article
http://www.ft.com/cms/s/0/452dc484-9bdc-11de-b214-00144feabdc0.html

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Received on Thu Nov 5 13:45:36 2009