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This paper investigates what we can learn from the financial crisis about the link between accounting and financial stability. The picture that emerges ten years after the crisis is substantially different from the picture that dominated the accounting debate during and shortly after the crisis. Widespread claims about the role of fair-value (or mark-to-market) accounting in the crisis have been debunked. However, we identify several other core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, banks delayed the recognition of loan losses. Banks’ incentives seem to drive this evidence, suggesting that reporting discretion and enforcement deserve careful consideration. In addition, bank regulation through its interlinkage with financial accounting may have dampened banks’ incentives for corrective actions. Our analysis illustrates that a number of serious challenges remain if accounting and financial reporting are to contribute to financial stability.
We analyze cyclical co-movement in credit, house prices, equity prices, and longterm interest rates across 17 advanced economies. Using a time-varying multi-level dynamic factor model and more than 130 years of data, we analyze the dynamics of co-movement at different levels of aggregation and compare recent developments to earlier episodes such as the early era of financial globalization from 1880 to 1913 and the Great Depression. We find that joint global dynamics across various financial quantities and prices as well as variable-specific global co-movements are important to explain fluctuations in the data. From a historical perspective, global co-movement in financial variables is not a new phenomenon, but its importance has increased for some variables since the 1980s. For equity prices, global cycles play currently a historically unprecedented role, explaining more than half of the fluctuations in the data. Global cycles in credit and housing have become much more pronounced and longer, but their importance in explaining dynamics has only increased for some economies including the US, the UK and Nordic European countries. We also include GDP in the analysis and find an increasing role for a global business cycle.
We propose a simple modification of the time series filter by Hamilton (2018) that yields reliable and economically meaningful real-time output gap estimates. The original filter relies on 8-quarter-ahead forecast errors of a simple autoregression of log real GDP. While this approach yields a cyclical component of GDP that is hardly revised with new incoming data due to the one-sided filtering approach, it does not cover typical business cycle frequencies evenly, but short business cycles are muted and medium length business cycles are amplified. Further, the estimated trend is as volatile as GDP itself and can thus hardly be interpreted as potential GDP. A simple modification that is based on the mean of 4- to 12-quarter-ahead forecast errors shares the favorable real-time properties of the Hamilton filter, but leads to a much better coverage of typical business cycle frequencies and a smooth estimated trend. Based on output growth and inflation forecasts and a comparison to revised output gap estimates from policy institutions, we find that real-time output gaps based on the modified Hamilton filter are economically much more meaningful measures of the business cycle than those based on other simple statistical trend-cycle decomposition techniques such as the HP or the Bandpass filter.
The financial crisis of 2007-08 has stressed the importance of a sound financial system. Unlike other studies weighing the pros and cons of market versus bank-based systems, this paper investigates whether the main elements of the German financial system can be regarded as complementary and consistent. This assessment refers to the idea that there is a potential for positive interaction between different elements in the system that is actually used to make it more valuable to economy and society and more robust to crises. It is shown that the old German bank-based system, where the risk of long-term lending by large private commercial banks was limited by the membership in supervisory boards and strong personal ties between all stakeholders, was a consistent system of well-adjusted complementary elements. After reunification, a hybrid system has emerged where, on the one hand, public savings banks and cooperative banks maintain their role as lenders, but on the other, large private banks have withdrawn from their former dominant role in financing and corporate governance. It is argued that this transition to stronger capital-market and, accordingly, shareholder value orientations has occurred at the expense of consistency.
The term structure of interest rates is crucial for the transmission of monetary policy to financial markets and the macroeconomy. Disentangling the impact of monetary policy on the components of interest rates, expected short rates and term premia, is essential to understanding this channel. To accomplish this, we provide a quantitative structural model with endogenous, time-varying term premia that are consistent with empirical findings. News about future policy, in contrast to unexpected policy shocks, has quantitatively significant effects on term premia along the entire term structure. This provides a plausible explanation for partly contradictory estimates in the empirical literature.
In the course of the crisis, the European System of Central Banks (ESCB) has acted several times to support the EU Member States and banking systems in financial distress by purchasing debt instruments: Covered Bonds Programmes (CBP), Securities Market Programmes (SMP), Long Term Refinancing Operations (LTRO), and Targeted Long Term Refinancing Operations (TLTRO), followed by the Outright Monetary Transactions (OMT) and then the Extended Asset Purchase Programmes (EAPP) – colloquially labelled as Quantitative Easing (QE).
Initially, the support measures of the ESCB might have to be judged as monetary policy but the selectivity of OMT and – even more – SMP in conjunction with the transfer of risks to the ESCB speak against it.
We analyze debt and debt management of Americans nearing retirement age. We show that older people have numerous financial obligations that can lead to financial distress. Using data from the 2015 National Financial Capability Study and an extensive literature review, we show that lack of financial literacy, lack of information, and behavioral biases help explain the prevalence of debt later in life. Our evidence indicates that debt at older ages can negatively influence retirement well-being.
We study the information flow from the ECB on policy dates since its inception, using tick data. We show that three factors capture about all of the variation in the yield curve but that these are different factors with different variance shares in the window that contains the policy decision announcement and the window that contains the press conference. We also show that the QE-related policy factor has been dominant in the recent period and that Forward Guidance and QE effects have been very persistent on the longer-end of the yield curve. We further show that broad and banking stock indices' responses to monetary policy surprises depended on the perceived nature of the surprises. We find no evidence of asymmetric responses of financial markets to positive and negative surprises, in contrast to the literature on asymmetric real effects of monetary policy. Lastly, we show how to implement our methodology for any policy-related news release, such as policymaker speeches. To carry out the analysis, we construct the Euro Area Monetary Policy Event- Study Database (EA-MPD). This database, which contains intraday asset price changes around the policy decision announcement as well as around the press conference, is a contribution on its own right and we expect it to be the standard in monetary policy research for the euro area.
We show that "quasi-dark" trading venues, i.e., markets with somewhat non-transparent trading mechanisms, are important parts of modern equity market structure alongside lit markets and dark pools. Using the European MiFID II regulation as a quasi-natural experiment, we find that dark pool bans lead to (i) volume spill-overs into quasi-dark trading mechanisms including periodic auctions and order internalization systems; (ii) little volume returning to transparent public markets; and consequently, (iii) a negligible impact on market liquidity and short-term price efficiency. These results show that quasi-dark markets serve as close substitutes for dark pools and consequently mitigate the effectiveness of dark pool regulation. Our findings highlight the need for a broader approach to transparency regulation in modern markets that takes into consideration the many alternative forms of quasi-dark trading.
We study how the informativeness of stock prices changes with the presence of high-frequency trading (HFT). Our estimate is based on the staggered start of HFT participation in a panel of international exchanges. With HFT presence, market prices are a less reliable predictor of future cash flows and investment, even more so for longer horizons. Further, firm-level idiosyncratic volatility decreases, and the holdings and trades by institutional investors deviate less from the market-capitalization weighted portfolio as a benchmark. Our results document that the informativeness of prices decreases subsequent to the start of HFT. These findings are consistent with theoretical models of HFTs' ability to anticipate informed order flow, resulting in decreased incentives to acquire fundamental information.