The role of credit in affecting asset prices
- The rate of growth of credit is an important determinant of asset prices
- Credit creation is pro-cyclical; it increases when sentiment is positive and vice versa
- Shadow banking has altered the credit landscape
- Investors and policy makers habitually fail to manage changes in the credit landscape well
“More credit extended more often means higher asset prices ... This is not capitalism he suggests, but ‘creditism’."
"But every mania has been associated with the expansion of credit. In the last hundred or so years the expansion of credit has been almost exclusively through the banks and financial system; earlier, non bank lender expanded the supply of credit."
“We need to move away from the old view that asset pricing is all about risk and corporate finance is all about agency problems. Both areas can usefully adopt part of the perspective of the other.”
"Assets purchased with credit, both real and financial assets, eventually yield returns that are inadequate to service the debts associated with their purchase."
"In effect, traditional relationship banking is replaced by a collateralized market system with the repo market at its heart ... While seemingly convenient to the financial institutions involved, shadow banking activities have significant externalities (or systemic risks) for the financial system as a whole."
William R. White, "Ultra easy monetary policy and the law of unintended consequences”, Federal Reserve Bank of Dallas, August 2012
"No careful reader of Friedman and Schwartz will be surprised by this lesson about the ability of governments to mismanage financial markets, a key theme of their analysis."
Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly, 2009
- It is important to consider past economic growth and asset appreciation in the context of high credit growth; it's not just fundamentals
- Problems tend to arise when new substitutes are developed for existing credit arrangements
- An important element of credit growth has been shadow banking and these activities make the financial system more cyclical and more fragile