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South West Economy Essay

2628 words - 11 pages

FEDERAL RESERVE BANK OF DALLAS

Issue 2 March /April 2003

Southwest Economy
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What Wages and Property Values Say About Texas
Two principal factors determine which cities experience the most rapid economic growth: business investment and labor growth. Business investment is high in cities where productivity is high relative to the cost of production. Workers are most attracted to cities where the amenities and wages are high relative to the cost of living. Together, wages and property values convey considerable information about a city’s productivity and amenities, and therefore about its growth potential. Taken independently, however, neither ...view middle of the document...

Moreover, recent data provide evidence that despite talk of a breakdown, the banking system has been remarkably resilient. Contrary to popular claims, the free market policies instituted in the 1990s have contributed to, rather than detracted from, the industry’s stability. (Continued on page 5)

Debunking Derivatives Delirium
(Continued from front page)

Then and Now
It’s becoming increasingly difficult to recall the boom years of the 1990s, but one hallmark of the period was a policy emphasis on free markets. A good example of those policies involves banks’ increasing use of derivatives. Financial derivatives—such as interest rate swaps, options and futures— may seem arcane, but they influence everyday life more than might be thought. For example, derivatives help improve the terms of home mortgage loans. Large banks dominate the market in over-the-counter derivatives, which are traded directly between companies without going through an exchange. In the 1990s, policymakers debated whether to regulate these activities. But free market proponents prevailed, and banks’ derivatives activities were allowed to develop and grow. Driving these policies was the belief that free financial markets would result in stronger banks. Competition and innovation, it was predicted, would spawn new technologies and practices that would help banks manage risk more effectively. More recently, the policies adopted in the 1990s have been subjected to much second-guessing. Banks are under Chart 1

fire for dealing in what some consider an alarmingly high volume of complex and risky derivatives. The thinking is that free markets have encouraged financial innovation all right, but it has taken unexpected and unwanted forms, like hard-to-detect accounting fraud, and has increased, rather than reduced, risk in the banking system. As a result, some advocate greater government control over financial markets, including banks’ derivatives activities.

Fact Versus Fiction
Derivatives usage has grown a lot, propelled by advances in information technology and financial theory. But the magnitude of derivatives activities is often exaggerated, contributing to a false sense of alarm. Based on notional value, the measure the media typically use, U.S. commercial banks now hold about $55 trillion in derivatives, compared with $7 trillion in 1990 (Chart 1 ). Interest rate contracts account for the vast majority.1 But while derivatives activities have grown tremendously by any measure, notional value overstates their magnitude. The notional $55 trillion is roughly five times the U.S. economy’s annual output. Such an amazing figure should

Competition and innovation, it was predicted, would spawn new technologies and practices that would help banks manage risk more effectively.

Derivatives at Banks
Notional value (trillions of dollars) 60 Contracts on commodities and equities 50 Interest rate contracts Foreign exchange contracts 40

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20

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0 1990

1991

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