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881. Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment

Author:
Dean Karlan and Jonathan Zinman
Publication Date:
01-2007
Content Type:
Working Paper
Institution:
Center for Global Development
Abstract:
Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and importance of adverse selection and moral hazard in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers issued by a major South African lender along three dimensions: 1) an initial "offer interest rate" featured on a direct mail solicitation; 2) a "contract interest rate" that was revealed only after a borrower agreed to the initial offer rate; and 3) a dynamic repayment incentive that extended preferential pricing on future loans to borrowers who remained in good standing. These three randomizations, combined with complete knowledge of the Lender's information set, permit identification of specific types of private information problems. Our setup distinguishes adverse selection from moral hazard effects on repayment, and thereby generates unique evidence on the existence and magnitudes of specific credit market frictions. We find evidence of moral hazard and weaker evidence for adverse selection. A rough calibration suggests that perhaps 7% to 16% of default is due to asymmetric information problems. Asymmetric information may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers at very high rates.
Topic:
Civil Society, Development, Markets, and Poverty
Political Geography:
South Africa

882. Expanding Credit Access: Using Randomized Supply Decisions to Estimate the Impacts

Author:
Dean Karlan and Jonathan Zinman
Publication Date:
01-2007
Content Type:
Working Paper
Institution:
Center for Global Development
Abstract:
Expanding credit access is a key ingredient of development strategies worldwide. Microfinance practitioners, policymakers, and donors have ambitious goals for expanding access, and seek efficient methods for implementing and evaluating expansion. There is less consensus on the role of consumer credit in expansion initiatives. Some microfinance institutions are moving beyond entrepreneurial credit and offering consumer loans. But many practitioners and policymakers are skeptical about “unproductive” lending. These concerns are fueled by academic work highlighting behavioral biases that may induce consumers to overborrow. We estimate the impacts of a consumer credit supply expansion using a field experiment and follow-up data collection. A South African lender relaxed its risk assessment criteria by encouraging its loan officers to approve randomly selected marginal rejected applications. We estimate the resulting impacts using new survey data on borrower behavior and well-being, and administrative data on loan repayment. We find that the marginal loans increased credit access and produced measurable benefits in the form of increased employment, reduced hunger, and reduced poverty. The marginal loans also appear to have been profitable for the lender. The results must be interpreted with caution but suggest that consumer credit expansions can be welfare-improving.
Topic:
Development, Markets, and Poverty
Political Geography:
Africa and South Africa

883. The Korea-US Free Trade Agreement: A Summary Assessment

Author:
Jeffrey J. Schott
Publication Date:
08-2007
Content Type:
Policy Brief
Institution:
Peterson Institute for International Economics
Abstract:
The Korea–United States Free Trade Agreement (KORUS FTA) is a historic accord that should enhance bilateral economic rela¬tions and reinforce our longstanding partnership on political and security matters. Like any negotiated deal, the KORUS FTA is not the optimal result for either country, but it provides substan¬tial benefits that make Korea and the United States considerably better off than they would be in the absence of the pact.
Topic:
Markets
Political Geography:
United States, Asia, and North Korea

884. North Korea's External Economic Relations

Author:
Stephan Haggard and Marcus Noland
Publication Date:
08-2007
Content Type:
Working Paper
Institution:
Peterson Institute for International Economics
Abstract:
North Korea's international transactions have grown since the 1990s famine period. Illicit transactions appear to account for a declining share of trade. Direct investment is rising, but the county remains significantly dependent on aid to finance imports. Interdependence with South Korea and China is rising, but the nature of integration with these two partners is very different: China's interaction with North Korea appears to be increasingly on market-oriented terms, while South Korea's involvement has a growing noncommercial or aid component. These patterns have implications for North Korea's development, the effectiveness of UN sanctions, and its bargaining behavior in nuclear negotiations.
Topic:
Markets and United Nations
Political Geography:
China, Asia, and North Korea

885. Do Markets Care Who Chairs the Central Bank?

Author:
Adam S. Posen and Kenneth N. Kuttner
Publication Date:
05-2007
Content Type:
Working Paper
Institution:
Peterson Institute for International Economics
Abstract:
This paper assesses the effects of central bank governor appointments on financial market expectations of monetary policy. To measure these effects, we assemble a new dataset of appointment announcements from 15 countries, and conduct an event study analysis on exchange rates, bond yields, and stock prices. The analysis reveals a significant reaction of exchange rates and bond yields to unexpected appointments. The reactions are not unidirectional, and thus do not suggest new governors suffer from a generic credibility problem. Federal Reserve chairman appointments stand out in terms of their unusually pronounced effects on financial markets.
Topic:
Economics, International Trade and Finance, Markets, and Politics

886. Why Do Financial Firms Take Too Much Risk?

Author:
John H. Makin
Publication Date:
12-2007
Content Type:
Policy Brief
Institution:
American Enterprise Institute for Public Policy Research
Abstract:
It is important at the outset to define the terms “financial firms” and “too much risk.” By “financial firms,” I mean commercial banks, investment banks, brokerages, and insurance companies that solicit and manage funds for the public. By “too much risk,” I mean actions undertaken by managers of financial firms that result in substantial losses for the shareholders (owners) of such firms. On an aggregate level, I call “systemic risks” those that emerge when regulators and policymakers are forced to choose between either reinforcing (with bailouts) the venturesome investing that created the problem or allowing substantial damage to depositors and shareholders in financial firms, and possibly to the economy as a whole.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States

887. One Fix Too Many

Author:
John H. Makin
Publication Date:
11-2007
Content Type:
Policy Brief
Institution:
American Enterprise Institute for Public Policy Research
Abstract:
Just as Wall Street was celebrating the presumed end of the latest financial crisis by pushing stocks to record highs, proclaiming continued strong earnings growth, and continuing to recite the mantra “slowdown, but no recession,” Treasury Secretary Henry Paulson provided a vivid reminder that the housing and mortgage crisis is not over. On Monday, October 15, while Citibank was reporting that compared with last year's results its third-quarter earnings had fallen by 57 percent, the Treasury's “super-SIV” plan was revealed. It seems that the Goldman Sachs alumni at Treasury—Paulson and his under secretary for domestic finance, Robert Steel—had become concerned that the offbalance- sheet special investment vehicles (SIVs) held by commercial banks might not be financeable. That would mean that not enough investors could be found to provide the short-term financing necessary to sustain SIVs, the repositories of hardto- value securitized mortgages that continue to plague bank balance sheets.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States

888. Global Rebalancing

Author:
John H. Makin
Publication Date:
10-2007
Content Type:
Policy Brief
Institution:
American Enterprise Institute for Public Policy Research
Abstract:
The global economic and financial picture is changing rapidly. A review of some of the key elements is in order, as the U.S. economy has slowed rapidly and the Federal Reserve has responded aggressively with rate cuts, while the Bank of England's tough policies pushed one of the United Kingdom's largest mortgage lenders, Northern Rock, to the brink of collapse as a bank run on that suddenly beleaguered institution ensued. Meanwhile, Japan, still the world's second-largest economy—though perhaps the least dynamic of the major ones—slipped into negative growth at a 1.2 percent annual rate in the second quarter after having initially reported growth over 2 percent. The rate-boost-obsessed Bank of Japan finally decided to stop raising rates, and, to add to the complexity of the picture, Japan's relatively new prime minister Shinzo Abe resigned, unable to provide the leadership sorely needed in a nation lacking economic and political direction.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States, Japan, United Kingdom, and England

889. The Music Stops

Author:
John H. Makin
Publication Date:
09-2007
Content Type:
Policy Brief
Institution:
American Enterprise Institute for Public Policy Research
Abstract:
During a 10:00 a.m. conference call on August 17, 2007, Federal Reserve vice chairman Donald Kohn and New York Federal Reserve president Timothy Geithner were urging Citicorp chief executive Chuck Prince and his fellow big bank CEOs to use the Fed's discount window, which is set up to alleviate liquidity pressures on individual banks or on the banking system as a whole. Prince, the head of the world's largest bank (Or is it the second largest? No one really knows since bank balance sheets are so full of securities that cannot be priced.) may have been wishing that he had not chosen to offer a chillingly clear characterization of the global financial system a little more than five weeks earlier in a Financial Times interview on July 9, three weeks before the global credit markets began to seize up.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States

890. The Band Plays On

Author:
John H. Makin
Publication Date:
08-2007
Content Type:
Policy Brief
Institution:
American Enterprise Institute for Public Policy Research
Abstract:
In a July 9 interview in Tokyo with the Financial Times about the surging, liquidity-driven financial sector, Citigroup chief executive Chuck Prince characterized the situation in global financial markets more insightfully than some investors might have wished: “When the music stops, in terms of liquidity, things will get complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing.” Prince elaborated further, saying that (as the article paraphrased it) “the way big Wall Street banks and hedge funds had picked up troubled subprime mortgage lenders was an example of how 'liquidity rushes in' to fill the gap as others spot a buying opportunity.”
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States and Tokyo