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.Congress and three ineffective presidents14See Phillips (1954, pp.297 299). 178 Overview and Summary of Part 2largely watched from the sidelines.The events, outcomes, and victims aredescribed in Chapter 10.Because real interest rates were borderline negative during much of thedecade, the trade-weighted value of the dollar fell about twenty-five per-cent and the U.S.current account balance was positive on average.A fal-ling value of the dollar meant that U.S.firms could compete in global mar-kets without substantively restructuring themselves.Borrowers who wereexporters were richly rewarded during these years.European and Japanesefirms were forced to improve their technology, which paid them largedividends in the following decade.Speculators responded to the fallingvalue of the international exchange standard, the dollar, by making largeprofits in foreign exchange markets and bidding up the price of gold andsilver to absurdly high levels.European countries began serious efforts toconstruct a substitute for the dollar by limiting bilateral fluctuations in thevalues of their currencies.The snake was an early informal arrangementwhere many continental European countries attempted to limit variationsin the value of their currencies relative to the West German mark.After money market mutual funds began to expand rapidly in 1978 andthe Garn-St Germain Act of 1982, which created new high-yielding de-posit accounts, savers began to gain at the expense of borrowers, insurersof deposits, and, eventually, average taxpayers.The Federal Reserve s re-strictive monetary policy, beginning in late 1978, and the series of largeReagan administration tax cuts, beginning in 1981, caused both nominaland real interest rates and the trade-weighted value of the dollar to risesharply; the trade-weighted index (1973 = 100) nearly doubled from 85.5in January 1980 to 158.4 in February 1985.The Federal Reserve won thebattle against inflation, but its efforts inflicted heavy losses on several sec-tors of the economy.Farmers and farm equipment manufacturers weredevastated.The real cost of funds to borrowers soared and newly cheapimports from Japan and Europe severely impacted U.S.manufacturers.Much of the Midwest became a rust belt as manufacturing firms bore thebrunt of the fight against inflation.The surviving firms that could borrowand afford the high cost of funds restructured their enterprises, often relo-cated, and received high returns in the 1990s, like those realized by firmsin Japan and Europe in the 1980s.Large U.S.banks experienced losseswhen they had to renegotiate loans to developing countries that were dollardenominated and/or indexed to short-term interest rates.Beginning with the Plaza Hotel agreement of September 1985, an inter-national campaign was undertaken to reduce the value of the dollar.Thiscampaign contributed to a decrease in the U.S.trade deficit after 1987 anda sharp fall in the trade-weighted index of the dollar to 89.0 in April 1988.The merchandise trade deficit fell from $160 in 1987 to $74 billion in Evaluating the Changing Returns and Risk Exposures of Clients of Banks 1791991.The falling exchange rate together with the restructuring of indus-tries helped to improve the rate of return to firms especially those withan export specialization.Because the real interest rate was falling, mostborrowers gained relative to depositors, but real interest rates remainedhigh until the early 1990s.15The Tax Reform Act of 1986 changed rules on the deductibility of inter-est by households, which strongly favored individuals who could arrange aloan secured by residential real estate.Homeowners gained at the expenseof renters.The principal effect of the reform act was a surge in demand forreal estate loans, which is partly evident in Table 18, and a disproportion-ately higher rate of inflation of housing prices.Existing homeowners hadlarge capital gains and the distribution of housing wealth became more un-equal over time because the ratio of median to mean housing prices fell.16The yearend percentage of homeowners equity in household real estaterelative to its market value decreased almost monotonically from 65.8% in1989 to 54.8% in 2003.The ratio was 51.7% in the second quarter of2007.17 Thus, leverage and the risk exposure of homeowners rose as theysought to take advantage of the return from the almost unique tax shield af-forded by mortgage loans.Greenspan and Kennedy (2005) have reportedestimates of sizable net equity extractions from housing markets by home-owners between 1991 and 2005.The Tax Reform Act also limited the deductibility of losses that inves-tors could take on passive investments in commercial properties, which re-duced the effective demand for these properties.The passage of the act in1986 coincided with a construction boom in commercial building.As aconsequence, an excess supply of such buildings developed, which wasevidenced by very high vacancy rates and falling prices and rents.18 Com-mercial real estate loan losses coincided with and contributed to the highrate of bank failures during this period and the recession of the early1990s.The Federal Reserve responded to the recession tardily, but aggres-sively, by driving the real federal funds rate down to near zero in late 199215The real interest rate in this discussion is the nominal federal funds rate minusthe contemporaneous annualized percentage rate of change of the GDP implicitprice deflator.16From data reported in Part 1, it can be verified that the ratio of median tomean house prices in transactions fell from 83% in January 1986 to 79% in Janu-ary 2005 as prices rose.17Source: Board of Governors of the Federal Reserve System, Flow of FundsAccounts of the United States (March 10, 2000 and September 17, 2007, TableB.100).18See Hester (1992, p.127). 180 Overview and Summary of Part 2and 1993.The major consequence of this intervention was to allow banksto reduce the nominal interest rates that they were paying on deposits, be-cause federal funds and funds acquired through repurchase agreementswere good and increasingly inexpensive substitutes for a bank s core de-posits.For example, in January 1990 NOW accounts were paying 4.97%;they were only paying 1.84% in January 1994 and 1.98% in November1996, when the Federal Reserve stopped reporting these rates.19 Real inter-est rates paid on NOW accounts fell from about plus 0.50% to minus0.25% between 1990 and 1994.Similarly, on time deposits with a maturityof more than two and one-half years, the nominal interest rate banks paidwas 7.86% in January 1990; they were paying 4.30% in January 1994 and5 [ Pobierz całość w formacie PDF ]
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.Congress and three ineffective presidents14See Phillips (1954, pp.297 299). 178 Overview and Summary of Part 2largely watched from the sidelines.The events, outcomes, and victims aredescribed in Chapter 10.Because real interest rates were borderline negative during much of thedecade, the trade-weighted value of the dollar fell about twenty-five per-cent and the U.S.current account balance was positive on average.A fal-ling value of the dollar meant that U.S.firms could compete in global mar-kets without substantively restructuring themselves.Borrowers who wereexporters were richly rewarded during these years.European and Japanesefirms were forced to improve their technology, which paid them largedividends in the following decade.Speculators responded to the fallingvalue of the international exchange standard, the dollar, by making largeprofits in foreign exchange markets and bidding up the price of gold andsilver to absurdly high levels.European countries began serious efforts toconstruct a substitute for the dollar by limiting bilateral fluctuations in thevalues of their currencies.The snake was an early informal arrangementwhere many continental European countries attempted to limit variationsin the value of their currencies relative to the West German mark.After money market mutual funds began to expand rapidly in 1978 andthe Garn-St Germain Act of 1982, which created new high-yielding de-posit accounts, savers began to gain at the expense of borrowers, insurersof deposits, and, eventually, average taxpayers.The Federal Reserve s re-strictive monetary policy, beginning in late 1978, and the series of largeReagan administration tax cuts, beginning in 1981, caused both nominaland real interest rates and the trade-weighted value of the dollar to risesharply; the trade-weighted index (1973 = 100) nearly doubled from 85.5in January 1980 to 158.4 in February 1985.The Federal Reserve won thebattle against inflation, but its efforts inflicted heavy losses on several sec-tors of the economy.Farmers and farm equipment manufacturers weredevastated.The real cost of funds to borrowers soared and newly cheapimports from Japan and Europe severely impacted U.S.manufacturers.Much of the Midwest became a rust belt as manufacturing firms bore thebrunt of the fight against inflation.The surviving firms that could borrowand afford the high cost of funds restructured their enterprises, often relo-cated, and received high returns in the 1990s, like those realized by firmsin Japan and Europe in the 1980s.Large U.S.banks experienced losseswhen they had to renegotiate loans to developing countries that were dollardenominated and/or indexed to short-term interest rates.Beginning with the Plaza Hotel agreement of September 1985, an inter-national campaign was undertaken to reduce the value of the dollar.Thiscampaign contributed to a decrease in the U.S.trade deficit after 1987 anda sharp fall in the trade-weighted index of the dollar to 89.0 in April 1988.The merchandise trade deficit fell from $160 in 1987 to $74 billion in Evaluating the Changing Returns and Risk Exposures of Clients of Banks 1791991.The falling exchange rate together with the restructuring of indus-tries helped to improve the rate of return to firms especially those withan export specialization.Because the real interest rate was falling, mostborrowers gained relative to depositors, but real interest rates remainedhigh until the early 1990s.15The Tax Reform Act of 1986 changed rules on the deductibility of inter-est by households, which strongly favored individuals who could arrange aloan secured by residential real estate.Homeowners gained at the expenseof renters.The principal effect of the reform act was a surge in demand forreal estate loans, which is partly evident in Table 18, and a disproportion-ately higher rate of inflation of housing prices.Existing homeowners hadlarge capital gains and the distribution of housing wealth became more un-equal over time because the ratio of median to mean housing prices fell.16The yearend percentage of homeowners equity in household real estaterelative to its market value decreased almost monotonically from 65.8% in1989 to 54.8% in 2003.The ratio was 51.7% in the second quarter of2007.17 Thus, leverage and the risk exposure of homeowners rose as theysought to take advantage of the return from the almost unique tax shield af-forded by mortgage loans.Greenspan and Kennedy (2005) have reportedestimates of sizable net equity extractions from housing markets by home-owners between 1991 and 2005.The Tax Reform Act also limited the deductibility of losses that inves-tors could take on passive investments in commercial properties, which re-duced the effective demand for these properties.The passage of the act in1986 coincided with a construction boom in commercial building.As aconsequence, an excess supply of such buildings developed, which wasevidenced by very high vacancy rates and falling prices and rents.18 Com-mercial real estate loan losses coincided with and contributed to the highrate of bank failures during this period and the recession of the early1990s.The Federal Reserve responded to the recession tardily, but aggres-sively, by driving the real federal funds rate down to near zero in late 199215The real interest rate in this discussion is the nominal federal funds rate minusthe contemporaneous annualized percentage rate of change of the GDP implicitprice deflator.16From data reported in Part 1, it can be verified that the ratio of median tomean house prices in transactions fell from 83% in January 1986 to 79% in Janu-ary 2005 as prices rose.17Source: Board of Governors of the Federal Reserve System, Flow of FundsAccounts of the United States (March 10, 2000 and September 17, 2007, TableB.100).18See Hester (1992, p.127). 180 Overview and Summary of Part 2and 1993.The major consequence of this intervention was to allow banksto reduce the nominal interest rates that they were paying on deposits, be-cause federal funds and funds acquired through repurchase agreementswere good and increasingly inexpensive substitutes for a bank s core de-posits.For example, in January 1990 NOW accounts were paying 4.97%;they were only paying 1.84% in January 1994 and 1.98% in November1996, when the Federal Reserve stopped reporting these rates.19 Real inter-est rates paid on NOW accounts fell from about plus 0.50% to minus0.25% between 1990 and 1994.Similarly, on time deposits with a maturityof more than two and one-half years, the nominal interest rate banks paidwas 7.86% in January 1990; they were paying 4.30% in January 1994 and5 [ Pobierz całość w formacie PDF ]