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41. The Replacement of Safe Assets: Evidence from the U.S. Bond Portfolio

Author:
Carol C. Bertaut, Alexandra Tabova, and Vivian Wong
Publication Date:
11-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The expansion in financial sector "safe" assets, largely in the form of structured products from the U.S. and the Caribbean, in the lead-up to the global financial crisis has by now been fairly well documented. Using a unique dataset derived from security-level data on U.S. portfolio holdings of foreign securities, we show that since the crisis, it is mostly the foreign financial sector that appears to have met U.S. demand for safe and liquid investment assets by expanding its supply of debt securities. We also find a strong negative correlation between the foreign share of the U.S. financial bond portfolio and measures of U.S. safe assets availability: providing evidence on the importance of foreign-issued financial sector debt as a substitute when U.S. issued "safe" assets are scarce. Furthermore, although U.S. investors continue to tap foreign financial markets for "safe" assets, we show that the type of foreign financial debt that fills this portfolio niche post-crisis is quite different than pre-crisis. Post-crisis, we find that U.S. investors have replaced offshore-issued structured securities with high-grade U.S. dollar-denominated financial debt issued from a small group of OECD countries (most notably Australia and Canada). Lastly, these developments have led to a decline in home bias in the U.S. financial bond portfolio that we are able to document for the first time.
Topic:
Foreign Exchange, Financial Crisis, Investment, Fiscal Policy, and Bonds
Political Geography:
Caribbean, North America, and United States of America

42. On Returns Differentials

Author:
Stephanie E. Curcuru, Charles Thomas, and Francis E. Warnock
Publication Date:
04-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Estimates of U.S. returns differentials have ranged from exorbitant to quite small, in part because of their volatility coupled with the relatively short time series available. We shed light on underlying drivers of returns differentials by presenting a number of decompositions: a by-asset-class decomposition into yields and capital gains, the Gourinchas and Rey (2007a) composition and return effects, and further decompositions of capital gains that focus on exchange rate effects. While each decomposition informs thinking about returns differentials, one constant is evident throughout: to date the existing differential favoring the U.S. has owed primarily to one factor, a differential in direct investment yields. We discuss how our analysis informs the income puzzle (of positive net income flows to the U.S. even as its net international investment position is negative and substantial) and the position puzzle (of a sizeable gap between the reported U.S. net international position and cumulated current account deficits), provide an initial assessment of the literature on the dynamics of returns differentials, and present a framework to guide a forward-looking view of how returns differentials might evolve in the future.
Topic:
Foreign Direct Investment, Financial Markets, Investment, and Stock Markets
Political Geography:
North America and United States of America

43. "Fool Me Once . . . " Did U.S. Investors Play it Safer in the European Debt Crisis?

Author:
Carol C. Bertaut, Fang Cai, and Nyssa Kim
Publication Date:
08-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper examines U.S. investors' portfolio investment patterns since the global financial crisis, particularly since the European debt crisis that began in late 2009. The global financial crisis during 2007-2009 was accompanied by an increase in U.S. investors' home bias. U.S. investors experienced significant valuation losses and pulled back notably from their foreign investment, especially from foreign debt. In contrast, while they have also incurred sizable losses on cross-border investment during the European debt crisis, U.S. investors so far have not shown any increase in home bias, and they have not even pulled back from their long-term investments in Europe. Holdings data show that U.S. investors have continued to invest in European securities, particularly in government debt, but have made little new investment in the financial sector. This continued interest in European securities could owe to the fact that most of U.S. holdings of European debt have been concentrated in dollar-denominated debt issued by core euro area countries and the United Kingdom, which are deemed relatively safe. Changes in the composition of holdings over the past couple years suggest that U.S. investors have behaved in a way that reflects their diversity and differing objectives: while investors reached for higher yields in government debt, there also appears to be some shift toward safer investment in the financial sector.
Topic:
Debt, Financial Crisis, Investment, Securities, and Stock Markets
Political Geography:
Europe, North America, and United States of America

44. U.S. International Equity Investment and Past Prospective Returns

Author:
John Armmer, Sara B. Holland, David C Smith, and Francis E. Warnock
Publication Date:
03-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
U.S. investors are the largest group of international equity investors in the world, but to date conclusive evidence on which types of foreign firms are able to attract U.S. investment is not available. Using a comprehensive dataset of all U.S. investment in foreign equities, we find that the single most important determinant of the amount of U.S. investment a foreign firm receives is whether the firm cross-lists on a U.S. exchange. Correcting for selection biases, cross-listing leads to a doubling (or more) in U.S. investment, an impact greater than all other factors combined. We also show that our firm-level analysis has implications for country-level studies, suggesting that research investigating equity investment patterns at the country-level should include cross-listing as an endogenous control variable. We describe easy-to-implement methods for including the importance of cross-listing at the country level.
Topic:
International Cooperation, Exchange Rate Policy, Investment, and Equity
Political Geography:
North America and United States of America

45. When Good Investments Go Bad: The Contraction in Community Bank Lending After the 2008 GSE Takeover

Author:
Tara Rice and Jonathan Rose
Publication Date:
03-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
n September 2008, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were placed into conservatorship and dividend payments on common and preferred shares were suspended. As a result, share prices fell to nearly zero and many banks across the country lost the value of their investments in the preferred shares. We estimate more than 600 depository institutions in the United States were exposed to at least $8 billion in investment losses from these securities. In addition, fifteen failures and two distressed mergers either directly or indirectly resulted from the takeover. Since these GSE investments were considered to be safe investments by banks, regulators, and rating agencies, we consider these losses to be exogenous shocks to bank capital, and use this event to examine the relationship between community bank condition and lending during this crisis. We find that in the quarter following the takeover of Fannie Mae and Freddie Mac, the measured Tier 1 capital ratio at exposed banks fell about three percent on average, and loan growth at exposed banks with median capitalization was about 2 percentage points lower compared to other banks in the following quarter. Consequently, considering the set of community banks that incurred about $2 billion in GSE-related losses, and assuming that each bank reduced loan growth by 2 percentage points, the estimated aggregate lending drop among these banks would be roughly $4 billion.
Topic:
Investment, Lending, Banking, and Banking Crisis
Political Geography:
North America and United States of America

46. The Return on U.S. Direct Investment at Home and Abroad

Author:
Stephanie E. Curcuru and Charles Thomas
Publication Date:
10-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A longstanding puzzle is that the United States is a net borrower from the rest of the world, yet continues to receive income on its external position. A large difference between the yields on direct investment at home and abroad is responsible and this paper examines potential explanations for this differential. We find that most of the differential disappears after one adjusts for the U.S. taxes owed by the parent on foreign earnings, the sovereign risk and sunk costs associated with investing abroad, and the age of foreign direct investment in the U.S.. Taken together, our results suggest most of the difference in yields should remain as long as there is a difference in tax rates between the United States and the countries in which U.S. firms invest, and U.S. investments are perceived as relatively safe. This has implications for the long-run sustainability of the U.S. current account deficit which will depend, in part, on the long-run behavior of this income.
Topic:
Economics, International Cooperation, Foreign Direct Investment, Tax Systems, and Investment
Political Geography:
North America and United States of America

47. U.S. International Equity Investment and Past Prospective Returns

Author:
Stephanie E. Curcuru, Charles Thomas, Francis E. Warnock, and Jon Wongswan
Publication Date:
02-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per year.
Topic:
Economics, Finance, Investment, Stock Markets, and Equity
Political Geography:
North America and United States of America

48. Housing and Debt Over the Life Cycle and Over the Business Cycle

Author:
Matteo Iacoviello
Publication Date:
10-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We study housing and debt in a quantitative general equilibrium model. In the cross-section, the model matches the wealth distribution, the age pro.les of homeownership and mortgage debt, and the frequency of housing adjustment. In the time-series, the model matches the procyclicality and volatility of housing investment, and the procyclicality of mortgage debt. We use the model to conduct two experiments. First, we investigate the consequences of higher individual income risk and lower downpayments, and .nd that these two changes can explain, in the model and in the data, the reduced volatility of housing investment, the reduced procyclicality of mortgage debt, and a small fraction of the reduced volatility of GDP. Second, we use the model to look at the behavior of housing investment and mortgage debt in an experiment that mimics the Great Recession: we find that countercyclical financial conditions can account for large drops in housing activity and mortgage debt when the economy is hit by large negative shocks.
Topic:
Debt, Financial Crisis, Business, Investment, and Housing
Political Geography:
North America and United States of America

49. Current Account Sustainability and Relative Reliability

Author:
Stephanie E. Curcuru and Charles P. Thomas
Publication Date:
09-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The sustainability of the large and persistent U.S. current account deficits is one of the biggest issues currently being confronted by international macroeconomists. Some very plausible theories suggest that the substantial global imbalances can continue in a benign manner, other equally plausible theories predict a disorderly resolution, and in general it is very difficult to discern between competing theories. To inform the debates, we view competing theories through the perspective of the relative reliability of the data the theories rely on. Our analysis of the dark matter theory is cursory; from a relative reliability perspective, it fails as it is built on the assumption that an item that is largely unmeasured is the most accurate component of the entire set of international accounts. Similarly, the best data currently available suggest that U.S. returns differentials are much smaller than implied by the exorbitant privilege theory. Our analysis opens up questions about potential inconsistencies in the international accounts, which we address by providing rough estimates of various holes in the accounts.
Topic:
International Trade and Finance, Markets, and Investment
Political Geography:
United States and North America

50. Assessing the Potential for Further Foreign Demand for U.S. Assets: Has Financing U.S. Current Account Deficits Made Foreign Investors Overweight in U.S. Securities?

Author:
Carol C. Bertaut
Publication Date:
10-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Since 2001, foreign investors have acquired roughly $5 trillion in U.S. securities – more than doubling their holdings of U.S. equities and bonds – as both official and private inflows have financed record U.S. current account deficits. Although the rapid growth of foreign holdings of U.S. securities raises concerns that foreign investors may have become too heavily weighted in U.S. assets, foreign investors have not in fact materially changed the relative allocations between U.S. and other foreign securities in their portfolios in recent years. Based on data from the most recent comprehensive surveys of foreign portfolio investment, the 2006 IMF Coordinated Portfolio Investment Surveys (CPIS), most foreign investors remain relatively more underweight in both U.S. equities and bonds than they do in foreign securities in general. Although the underweight position suggests that there remains potential for foreign investors to continue to acquire U.S. securities, econometric evidence indicates that the underweight position itself reflects a preference by foreign investors for securities of countries with which they have strong economic or cultural ties, consistent with recent research that suggests “location” or “information” preferences in both domestic and international portfolios. As securities markets abroad continue to deepen, such factors are likely to continue to attract investment from “nearby” markets, especially from European investors.
Topic:
Investment, Securities, Bonds, and International Portfolios
Political Geography:
United States, Europe, and North America