Wednesday, November 21, 2018

Four Follow-Ups: Scandinavia, Equal Opportunity, Brexit, Leveraged Lending

I sometimes run across articles that offer additional follow-up on topics about which I've previously posted, or stories in the news that remind me of earlier posts. Here, I'll just offer short follow-ups on an eclectic set of four topics:

  • The Scandinavian style of capitalism, 
  • Economic gains from in equal opportunity
  • The news about Brexit
  • Possible systemic risks of the risks of leveraged lending

1)  "The Scandinavian Style of Capitalism" (November 5, 2018)

I wrote a few weeks ago about the actual specific attributes of the style of capitalism practiced in countries of northern Europe. (Hint: It isn't "socialism," and it has a number of traits of which many American supporters of a Scandinavian approach seem largely unaware.) A reader forwarded to me this report Sweden's Ministry of Finance  called "The Swedish Model" (June 20, 2017).

Some of the report is the kind of stuff that any government says when it is not-too-subtly praising itself. It's not incorrect, but it does tend to sidestep concerns and problem. From the perspective of an an American who often hears casual references to the Swedish model or Scandinavian model, it's interesting to consider the emphasis that the report puts on a shared social responsibility. Here's a representative paragraph:
"The distinguishing characteristics of the Swedish labour market are coordinated wage formation, an active labour market policy and effective unemployment insurance. The fundamental premise is that individuals should contribute through work and be willing to adjust to new tasks. Provided that individuals perform this part of the social contract, they qualify for rights in the form of income-related social security, and, after needs assessment by the Public Employment Service, active initiatives to facilitate the return to work after having become unemployed. In addition, there is a certain level of financial security for people who do not qualify for income-related social security benefits. The social partners also provide a large portion of support in connection with unemployment through various career readjustment agreements."
Some of those who favor what they think of as a Scandinavian approach to labor markets tend to emphasize the government benefits, but not to put an equal and counterbalancing emphasis on the responsibility of individuals to adjust to new tasks and careers. The report also emphasizes the importance in the Swedish model of a fiscal policy that "is sustainable over the long term ... with surplus targets, expenditure ceilings, a municipal balanced budget requirement and rigorous budget process," as well as the central importance of promoting competitiveness in open international trade
2) "Equal Opportunity and Economic Growth" (August 1, 2012)

Back in 2012, I noted a study of how improvements in equal opportunity benefit economic growth, because an economy that makes fuller use of its human resources will be larger. For an illustration of shifts toward more equal opportunity, Pete Klenow offered this table. Based on joint research with others, he argued that about 15-20% of total US growth from 1960 to 2008 can be explained by women and African-Americans investing more in human capital and working in high-skill occupations.

For those who would like to see the underlying research behind this result, the most recent (April 6, 2018) version of the research paper is available at Klenow's website. Their current estimate is that "[a]bout one-quarter of growth in aggregate output per person over this period [from 1960 to 2010] can be explained by the improved allocation of talent." There's a cautionary insight her about how how academic research really works. The preview of these findings from six years ago, back in 2012, has mostly the same bottom line result as the current paper. But the authors have spent years writing and revising to sharpen the analysis and to address detailed questions that have been raised. And the paper isn't published yet.

3) The United Kingdom and the European Union have agreed on the text of a draft agreement for how the UK might leave the EU. The news stories caused me to reflect on two earlier posts. In
"Seven reflections on Brexit" (June 27, 2016), I offered some thoughts in the immediate aftermath of the Brexit vote. For example, here was my first point:
1) The Brexit vote seemed to me a strangely American moment. Some of the lasting slogans handed down from the American revolution against England are "no taxation without representation" and "don't tread on me." Thus, for an American there was some historical irony in hearing many of the British argue, in effect, that there should be "no regulation without representation," or perhaps "no legislation without representation." There was similar irony in hearing some of the British turn loose their "don't tread on me" spirit while railing against annoying but in some sense small-scale regulatory impositions from the central power, like rules that sought to standardize shapes and sizes for fruit and vegetable produce, or the rules with force of law that sales of loose and packaged good use only metric measurements. I found myself half-expecting some "Leave" advocates to start quoting the US Declaration of Independence: "When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them ..."
For a discussion of the economic studies about Brexit options and their effects, see "Brexit: Getting Concrete about Next Steps" (August 2, 2016) and "Brexit: Still a Process, Not Yet a Destination" (November 17, 2017).

4) "Corporate Debt and Leveraged Loans: Financial Snags Ahead?" (September 21, 2018)

Stop me if you've heard this story before. Certain loans look too risky for any bank to make on its own. So groups of lenders combine to make such loans, and then repackage groups of these loans as complex financial securities, and then resell the in pieces to investors all over the economy.  Just which financial institutions are are exposed to the downside risks is unclear. But we do know that the volume of these loans is growing fast, while the credit standards applied to granting such loans has been declining. Although this general description seems as if it could apply to the wave of lending in US housing markets in the lead-up the Great Recession, it also applies to the current wave of what is called "leveraged lending."  For an earlier post on the subject, see "Leveraged Loans: A Danger Spot?" (October 4, 2014).

Three economists from the IMF, Tobias Adrian, Fabio Natalucci, and Thomas Piontek, have wrtten a recent blog post ""Sounding the Alarm on Leveraged Lending" (November 15, 2018). Among other concerns, they offer this figure:

Similarly, the Office of Financial Research has just published its Annual Report to Congress 2018, "which presents its assessment of the state of the U.S. financial system, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010." Its overall assessment is that "risks to U.S. financial stability are still in a medium range overall." But it highlights leveraged lending as an area of concern. The report notes:
"Rapid growth in leveraged lending is a concern. These commercial loans, often used by borrowers with credit ratings below investment grade for buyouts, acquisitions, or capital distributions, can leave borrowers highly indebted. Strong investor demand for these higher-yielding loans is behind the rapid growth. Less creditworthy corporations took advantage of that demand by seeking more funding in leveraged loan markets. As a result, more than $1 trillion of leveraged loans are outstanding. That is more than 11 percent of all U.S. nonfinancial debt — a record high. With the growth in leveraged lending has come a deterioration in the credit quality of newly issued loans. One sign of this decline is the high share of covenant-lite loans ... Covenants are restrictions placed on debt-issuing firms meant to increase the likelihood of payment. Another sign of deterioration in underwriting quality is that more than half of all leveraged loans issued are rated B+ or lower (that is, highly speculative). "
Investors in such bonds, and financial regulators, should be paying attention here.