Class Note for ECON 311 at UMass(2)
Class Note for ECON 311 at UMass(2)
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Date Created: 02/06/15
Leave the gun take the cannoli Pollin amp Mishkin 8 China Presentation and discussion by Andrew and Tai HW questions Copynght 2007 Peavson Addtsoanestey AH thts vesevved 81 What is Financial Structure How do rms get nancing for investment growth Who makes allocative decisions how is performance monitored and enforced 39How is the surplus distributed 39Who holds power in these interactions 39Which kinds of rms are growing and why Copynght 2007 Peavson AddisowWes ey AH thts vesevved 82 Laslnvmluemom airingrs thus I mama am 6 muhlpll s nu me 1933 Foreign Investment in the World quot inflows a quotman as s 7 7 250 can t r nuooc I m 83 m g WWW u m w m m International Piracy nus map shows an we pussy and armed munery modems ripened m me IMB F39uzcy Repoan cenue aunng auue If exact coordlnmes are null pmw ed Actual Anack g esumaxea pasmuus aye snown based on mtarmauon pmvmea lam m and duck on me pamleys 0 View mme mmrmaunn man Indmdua snack A A Fomlevs may he supenmposec on each other quotmmquot a 1 Mann AmtIke manna a m Inman mm mum Copwg H 84 LetlnvulluamlmsalunnumdnmInmnnda mm um mu m muhlpll l pm dc 1m a 1m 0 lnvzslrslnmlm war94v an mmnm as s zoo mo 49 mm vs ow 85 A we 51 intuit 1 mg wambmmzymv macaw may we Commodore Perry How different are these dudes 86 Western Offshoots Western Europe Southern Europe Latin America Eastern BJrope Copyngm 2007 Peavson Addwsoeres ey AH ngms vesevved 87 Growlng World lnequamy 60 Income Share of me Top um of me WanH39s Pnpuhthn 50 2 g 40 3 s E a E E 30 1 2 20 Income Share of u Hanan sow o1 Rho World Popuhllnn 0 1820 1950 1870 1900 l929 1950 1960 1970 1980 1992 Frmn BmJs F0 Jr s an rh ml 1 huulmq Gummymu Pump M an mewnm uHl V39Eu 4 J U Fink INNL Copyngm 2007 Peavson Addwsoeres ey AH ngms vesevved 88 Pirates need financing too Finance has virtue but 39 stealing is and always has been a big part of the financial realm Sometimes it39s hard to distinguish between piracy and legal practices Some institutions legitimize these behaviors some deter it Often same institutions doing both things Godfather tells a similar Copyright 2007 Pearson Addisoanesley All rights reserved 89 MIMI Jarnee S H nry quot11 55 Stillman Hittaiumrtir 39 Some things are legal because they operate beyond the reach of the law Copynght 2007 Peavson Addtsoanestey AH thts vesevved 810 Recap What financial markets should do Encourage appropriate level of savings 1 2 Transfer savings to those who can put resources to best use 3 Transfer risk to those most able to bear it 4 Facilitate real sector growth innovation in process and product technologies that underlie growth of living standards 5 Orderly dispute resolution Should financial markets be egalitarian Copyright 2007 Pearson Addisoanesley All rights reserved 811 Transaction Costs Financial intermediaries have evolved to reduce transaction costs 0 Economies of scale Marketing Trading costs market and nonmarket Credit evaluation monitoring and disciplining o Expertise Copyright 2007 Pearson Addisoanesley All rights reserved 812 Because of Coordination Failures Good credit risks will be excluded from financial markets Credit markets will be segmented along wealth dimensions People pay different interest rates People have access to different array of contractsopportunities Propensity toward frequent systemic crises Incentive for individual returns not necc aligned with social welfaresocial returns Copyright 2007 Pearson Addisoanesley All rights reserved 813 Adverse Selection The Lemons Problem It quality cannot be assessed the buyer is willing to pay at most a price that reflects the average quality Sellers of good quality items will not want to sell at the price for average quality The buyer will decide not to buy at all because all that is left in the market is poor quality items This problem explains fact 2 and partially explains fact 1 Copyright 2007 Pearson Addisoanesley All rights reserved 814 Adverse Selection Solutions Private production and sale of information Equifax credit scoring company Credit rating agencies Government regulation to increase information SEC tax auditing and statistical reporting Finan intermediation usedcar dealers 34 6 Collateral and net worth 7 Social preferences reputation social sanction positive assortation Copyright 2007 Pearson Addisoanesley All rights reserved 815 PrincipalAgent Problem Separation of ownership and control of the firm 0 Put personal benefits before profitability of the firm Put job security LT growth above short term growth 0 Conflict over external financing debt or eq Copyright 2007 Pearson Addisoanesley All rights reserved 816 PrincipalAgent Problem Solutions Monitoring Costly State Verification Freerider problem Fact 1 Government regulation to increase information Fact 5 Financial lntermediation Facts Debt Contracts Fact 1 817 Copyright 2007 Pearson Addisoanesley All rrgme reserved Moral Hazard in Debt Markets Borrowers have incentives to take on projects that are riskier than the lenders would like Copyright 2007 Pearson Addisoanesley All rights reserved 818 Moral Hazard Solutions Net worth and collateral Incentive compatible Monitoring and Enforcement of Restrictive Covenants Discourage undesirable behavior Encourage desirable behavior Keep collateral valuable Provide information 39 Financial lntermediation 34 Contingent renewal contracts Copyright 2007 Pearson Addisoanesiey All rights reserved 819 Conflicts of Interest What Mishkin says Type of moral hazard problem caused by economies of scope Arise when an institution has multiple objectives and as a result has conflicts between those objectives A reduction in the quality of information in financial markets increases asymmetric information problems Financial markets do not channel funds into productive investment opportunities The economy is not as efficient as it could be Negative externalities some costs not accounted in Copyright in zllflgg llg llglllt 4ng mortgage securitization 820 39 Financial Structure Bottom Line coon PAY coon MEALS GOOD suounu M WW WANT A BIND JUB in HUUEEHULU EMPLUW JEENT A w n n quotwe m ILLINDIS STATE EMPLWMENT SERVIEE Institutions are social constructions So wouldn39t it be a good idea to constructthem to achieve socially desirable goals inetattritwrtthtiiittitegttevefficiency and social welfare ow do companies raise external funds 7O 100 90 80 EI United States II Germany B Japan D Canada Nonbank Loans Bonds Bank Loans F I G URE 1 Sources of External Funds for Nonfinancial Businesses A Comparison of the United States with Germany Japan and Canada Source Andreas Hackethal and Reinhard H Schmidt quotFinancing Patterns Measurement Concepts and Empirical Resultsquot Johann Wolfgang GoetheUniversitat Working Paper No 125 January 2004 The data are from 19702000 and are gross flows as percentage of the total not including trade and other credit data which are not available Mishkin doesn39t tell you most companies financed internally thru retained earnings not externally financed Copyright 2007 Pearson AddisonWesley All rights reserved 822 Eight Basic Facts flquot if l 7 l 1 gt Hill and what they mean so 9 E United States I Germany El Japan I Canada 90 7O 6O 50 4O 30 20 10 18 o Bank Loans Nonbank Loans II F I G URE 1 So rces of External Fu for Nonfnancial Businesses Stocks are not the most2i 5H urce rea Johann Wolfgang GoetheUniversitat or in Pa ry 2004 The data are from 1970 2000 and are gross e xte rn al fi n a n Ci n 9 fo r busscm 933 g as 233322 Issuing marketable debt and equity securities is not the primary way in which businesses finance their operations Indirect finance is many times more important than direct finance Financial intermediaries are the most important source of external funds n Concep s and Empirical Resultsquot Eight Basic Facts and what they mean so r 60 D United States I Germany II Japan 1 El Canada 76 56 10 18 0 Bank Loans B d Stock iSmajf bEgjig gil gg e actlezts and Empirical Resultsquot reg U ated S e do rs of th e e COl g eVEgu aTiEilv ilili nggifff EstLittiitzzrjszf itshtrs straitsm Only large wellestablished corporations have easy access to securities markets to finance their activities Collateral is a prevalent feature of debt contracts Debt contracts are extremely complicated legal documents that place substantial restrictive covenants on borrowers Hirschman Exit VOiCe Loyalty 3 choicesstrategies of individual in relationships 39 Exit leaving the relationship 39 Voice attempt to change the relationship by voicing opinions 39 Loyalty disloyalty submit to or subvert the org Copynght 2007 Feavson Addisoanesley AH thts vesevved 825 Banks and K Mrkts Exit and Voice Banks 0 Germany France Japan E Asia 0 Relational lending 0 informationgathering 0 Voiceled ex ante intervention in governance K Mrkts 0 UK US 0 Armslength indirect relationship 0 2ndary trading of financial assets 0 Zysman gov39t plays more limited role 0 Exitled ex post interventions oResoond to ST financial incentives ModiglianiMiller McKinnonShaw MM Both Nobel winners Perfect K markets Firm indifferent to structure of external financing McKS Financial repression bad for growth So liberalize finance Should expand credit improve efficiency Copyright 2007 Pearson Addisoanesley All rights reserved 827 Man lifting a stone With a lever Leverage debt commitments payment outflows expected income streams Good leveraged to finance productive spending Bad leveraged to finance speculation compensatory spending Ugly debt and income flows mismatched Ponzi finance Safe sociallydetermined expectations and confidence Copyright 2007 Pearson Addisoanesley All lights reserv 828 Time horizons Hurdle rate US CEOs 122 vs bonds 2 and equities 7 RampD LT Germany 61 and Japan 47 spending gt US spending 23 Copynght 2007 Feavson Addisoanesiey Aii thts vesevved 829 Exitled versus Voiceled Voice Interventions shape longterm planning Bad mgmt change mgmt Whose voices Exit o Interventions only after the fact Bad mgmt change ownership Exit is easy public goods problem Strike a balance between Voice and Exit Copyright 2007 Pearson Addisoanesley All rights reserved 830 ExitVoice Solutions 1 Nationalize financial system Keynes39 idea of GT in part 2 Increasing voice in boards of directors investment pensions fund management Democratize central bank 3 4 Financial prudential regulation discourage speculaton Copyright 2007 Pearson Addisoanesley All rights reserved 831 BardanRoemer Model of Market Socialist Finance Case of China39s TVE sector m p EI i39fi 4 A Copynght 2007 Peavson Addwsoeres ey AH thts vesevved 832 The Chinese Growth Miracle 18 7000 6o x 16 n 6000 14 5000 12 of 316 10 9 39 40quotquot lbw 8 39 6 4 2 39 0 h f fffe wfffff f fy Sources Author39s calculation of CSYB 2006 and MF2007 339 1 Not Your Avg Free Market Economy NVEs 4 l x I 0day s government plays the role of both chief planner ggulator and owner of large parts of the residual of this mmunist system ChinaVest 2007 Haw WWM is Chaim Truly private firms incl foreign Reserve army of the selfemployed It depends what your de nition of is is Private rms Township amp Village Enterprises Corporatized SOEs Private Investment Fueling Growth ISOE lDom Pvt lForeign 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source Author39s calc of CSYB 2006 G s Stabilizing Hand 90 lNonPvtSH I Pvt lForeign 80 70 60 50 39 40 30 20 10 0 2332 at 2333332f ampg92033212003 2 04 2 05 90 80 70 60 50 40 Total Investment 30 20 10 0 Sources of Investment State Budget IDom Loans Foreign hSelfRaised By 1988 L gt 100 million By 1992 35 industrial output 40 percent X As productive as private and foreign jointventures Local officials 9 entrepreneurs Institutional innovations endure thru Neoliberal Consolidation Parable of the new industrial policy Discretionary enforcement 39Subsidized market discovery 39 Subsidized technology accumulation Highly competitive environment 90 80 70 60 50 40 Share of Total Inves ment 30 20 10 0 Decomposing SelfRaised amp Other Sources o Self Raised EXtrabudgetary forced savings Net Pro ts 19811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006 vf SHHNBHHI CDHPDSIT 83 0F 10 Oct 2008 8000 2006 2008 50 a 540 r 20 CD 00 a right 2008 Yahoo Inc httpKHFinanceyahoocomK Andrew and Tai on Pollin Copynght 2007 Feavson Addwsoeres ey AH thts vesevved 843 STATE of WORKING AMERICA 06 2007 MID FDlIEV INSTITUTE Mishkin Ch 7 S WA Ch 5 Wealth oooooooooooooooooooooooooooooooooooooooooooooooooo ed
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