Macro investment correlation

June 8, 2012 4:01 PM

Has there been an inverse relationship between the availability of exotic investment securities and levels of traditional bricks and mortar lending? This makes some intuitive sense to me but I don't know where to start in trying to support/verify. Does anyone know what some relevant indices might be?
posted by romines to society & culture (6 answers total)

Can you say anything more about your line of thinking on this? I'm a little unclear at what you're trying to get at and exotic investments can refer to a lot of very different things.
posted by triggerfinger at 4:19 PM on June 8, 2012

I am thinking about this in extremely general terms, which might make this and impossible question to answer. "Exotic investments" is intended to refer to investments that have only very abstract connection to traditional goods and services, as distinct from the kind of lending that (more or less) directly facilitates acquisition/construction of physical capital.

So maybe securities made up of actual mortgages, even if packaged and sliced count as un-exotic, whereas synthetic derivatives that trigger if Greece defaults count as exotic.

Maybe if I limit the question to: Has bank lending to non-financial services business as a percentage of all investment gone down since the 1999 Gramm-Leach-Bliley Act?
posted by romines at 4:58 PM on June 8, 2012

I don't have the chops to specifically answer your question, but it's generally accepted that the exotic-investments craze was fueled in part by the low-interest-rates, low-inflation policies of the Fed under Alan Greenspan. Basically, money was chasing returns; we saw this with Enron, and it flowed into the housing bubble when there were few other places to get high returns. This was the essentially the basis of his being questioned before the Financial Crisis Inquiry Commission in 2010.

If you're suggesting that this then "cornered" the lending/investment market versus traditional lending, I'm not sure that's valid. The market is not a zero-sum game, and the bubble inflated the available assets to a significant degree. I would say that the opposite took place: derivatives fueled an era of lax brick-and-mortar lending, as any number of still-troubled regional banks can suffice as example.
posted by dhartung at 5:23 PM on June 8, 2012

Are banks deriving a larger proportion of their revenues from usage of derivatives rather than traditional loans since the reversal of the part of Glass-Steagall that separated retail, investment and insurance banking; and is there a cause/effect relationship is how I understand your question.

There seem to be a few papers that may indirectly touch on what you're looking for:

Credit Derivatives and Bank Credit Supply (NY Federal Reserve, pdf)

We find evidence that greater use of credit derivatives is associated with greater supply of bank credit for large term loans -newly negotiated loan extensions to large corporate borrowers—though not for (previously negotiated) commitment lending. This finding suggests that the benefits of the growth of credit derivatives may be narrow, accruing mainly to large firms that are likely to be “named credits” in these transactions. Further, the impact is primarily on the terms of lending—longer loan maturity and lower spreads—rather than on loan volume.

Interest-rate derivatives and bank lending

We find that banks which utilized interest-rate derivatives experienced greater growth in their commercial and industrial (C&I) loan portfolios than banks which did not use these financial instruments. This result is consistent with the model of Diamond (1984) which predicts that intermediaries' use of derivatives enables increased reliance on their comparative advantage as delegated monitors.

The Bank Lending Channel: Lessons From the Crisis

Banks with weaker core capital positions, greater dependence on market funding and on non-interest sources of income restricted the loan supply more strongly during the crisis period.

There is also quite a bit out there on the usage of derivatives to reduce credit risk, but I don't think that's what you're getting at.
posted by triggerfinger at 6:20 PM on June 8, 2012

Perhaps the connection is simply: if more money can be made trading exotic investments, fewer dollars will go to traditional commercial banking business (retail lending). This is simply dis-intermediation: if hedge-fund and ibank offer higher interest rates, people will move their money from saving account to money market account or brokerage account. This in turn will reduce the commercial bank's balance sheet (traditionally filled with retail loans) and change their business into mortgage packager (i.e: making loans then turn around and sell the loan to Wall St to be turn into CDO and sell to investors and derivative traders).

However, there is a psychological element that may explain your intuition about the derivative market. Experiments have shown that the further people are removed from value, the less scruple they have regarding it. In the chain of value: goods/services <= money <= stocks <= options, the further remove from goods/services, the less guilt and the more brazen people feel when they steal or embezzle said instrument. So, derivative market will exhibit less scruple and attract greed than other markets that is closer to reality.
posted by curiousZ at 12:18 AM on June 9, 2012

The boom of exotic products coincided with a boom of brick and mortar lending becuase, of course, they are for the most part two sides of the same coin.

CBOs, CLOs, CDOs, ABS, MBS etc. simply sliced, diced and repackaged brick and mortar loans and bonds and by spreading risk around and/or isolating specific levels of risk in tranches permitted more loans and bonds to be issued.

CDS and synthetic CDOs and other credit derivatives at least in part existed to hedge brick and mortar loans and bonds (directly or on a portfolio basis), permitting them to be issued in greater size.
posted by MattD at 8:05 AM on June 9, 2012