Taylor & Francis, Ltd. Is Collaborating With JSTOR To Digitize, Preserve and Extend Access To Journal of Post Keynesian Economics

Financial Engineering, Consumer Credit, and the Stability of Effective Demand
Author(s): Christopher Brown

Source: Journal of Post Keynesian Economics, Vol. 29, No. 3 (Spring, 2007), pp. 427-453
Published by: Taylor & Francis, Ltd.
Stable URL: http://www.jstor.org/stable/4539024
Accessed: 03-09-2015 11:00 UTC
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://www.jstor.org/page/
info/about/policies/terms.jsp
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content
in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship.
For more information about JSTOR, please contact support@jstor.org.
Taylor & Francis, Ltd. is collaborating with JSTOR to digitize, preserve and extend access to Journal of Post Keynesian
Economics.
http://www.jstor.org
This content downloaded from 186.155.238.12 on Thu, 03 Sep 2015 11:00:47 UTC
All use subject to JSTOR Terms and Conditions
428 JOURNAL OF POST KEYNESIANECONOMICS
or educationalloans, is there a nascentthreatof instabilityarisingfrom

speculation?Finally, is financial engineering (partly)to blame for the
deterioratingstatusof a largenumberof householdbalancesheets in the
United States in the past 10 to 15 years?
What is financialengineering?
Financialengineeringis homologouswith the processof securitization-
that is, the reconfigurationof illiquid claims to future cash flows into
standardized,marketableassets. The termalso applies to the creationof
synthetic,derivativeinstrumentsthatenable institutions(pension funds
or universityendowments,for example) to hedge positions in securities
backed by conventionalmortgageor consumerloans. This papertakes
aim at two comparatively recent innovations-the mortgage-backed
security or MBS (tradable instrumentscollateralized mortgage loan
obligations) and the asset-backed security or ABS (collateralized by
consumerdebt).
The asset securitizationtechniquecan be brieflydescribedas follows:
A finance company specializes in the sale of hire-purchaseagreements
(installmentloans to finance cars, motorcycles, boats, or other items).
Finance companies historically financed positions taken in consumer
receivables throughbank loans or the directissue of commercialpaper.
Underthe new regime,consumerreceivablesaresold to a specialpurpose
vehicle (SPV)-that is, a company created for the express purpose of
structuringthese pools of futurecash flows into homogenous lots that
can be placed with large pension funds, insurancecompanies,and other
institutionalportfolios.A trustagreementis createdat the point of issued
that requiresthe transferof hire-purchaseagreements(or credit card or
studentloans receivables,as the case may be) to a trustnot controlledby
the loan originator(the financecompany)or the SPV.The newly issued
securities are "backed"by the assets of the trust-hence, the term as-
set-backedsecurities. The pool of assets in the trusthave been screened
by the originator,a ratingagency, and in some cases, by an independent
guarantor.The new notes issued by the SPV thereforecarryan invest-
ment grade,makingthem substitutablewith short-datedTreasuryissues
or commercialpaper.1The mechanics of placementfor ABSs are much
Schwartzexplains that "[a] securitizationtransactioncan provide obvious cost

savings by permittingan originatorwhose debt securitiesare ratedless thaninvest-
ment grade ... to obtain fundingthroughan SPV where debt securitieshave an in-
vestment grade"(1994, p. 137).
FINANCIALENGINEERING,CONSUMERCREDIT AND EFFECTIVEDEMAND 429
the same as for corporateequities or municipal bonds. A prospectus

must be circulated.Investmentbankstake the securitiesto market(and,
as might be expected, competitionfor the lucrativefees thatcan be real-
ized throughABS placementis fierce). The issuers of ABSs include all
majorplayers in the domestic consumerfinance industry.A partiallist-
ing includesWachoviaBank,HondaFinance,Nissan MotorAcceptance
Corporation,ToyotaMotorCredit,MitsubishiFinance,the CreditStore,
ChaseManhattanBank,CircuitCity,NiemanMarcus,Dillards,J.C.Pen-
ney, Sears, Dayton-Hudson,FederatedDepartmentStores, Banc One,
CapitalOne, Citicorp,FordMotor CreditCorporation,GeneralMotors
Acceptance Corporation,and Bank of America. Giddy notes that
[t]he asset securitizationprocess, while complex, has won a secureplace
in corporatefinancing and investment portfolios because it can, para-
doxically, offer originatorsa cheaper source of financing and investors
a superiorreturn.Not only does securitizationtransformilliquid assets
into tradablesecurities,but it also managesto transformrisk by means of
the separationof sound financialinstrumentsfrom a companywith little
or no loss. (2005)
TheABS markethas been buttressedby strongdemandin the past sev-

eral years as new issues have regularlybeen oversubscribed.In addition
to their liquidity and attractivereturn,these securities appealto banks,
insurancecompanies, pension funds, and other institutionsbecause the
risks of holding them can be hedged with the use of other structured
financialproducts-that is, derivatives.
Structuredfinance specialists identify two types of risk attachedto
ABSs (or MBSs)-interest raterisk and defaultrisk. Prepaymentriskis
a special categoryof interestraterisk andis mainly confinedto the MBS
segment. Because mortgagedebt instrumentstypically give borrowers
the option to pay off their notes at any time, MBSs have "embedded
call options" (Lee, 2003, p. A14). Profit margins of leveraged MBS
holders (particularlythose with substantiallong-termdebt) are interest-
sensitive because a decline in rates will cause a surge in prepayments
as homeowners refinanceon more favorable terms. The more general
form of interest rate risk arises from a mismatch between maturities
of liabilities and assets. The default risk affixed to specific categories
of ABSs or MBSs is, owing to explicit or implicit federal government
guarantees,virtuallynil. Forexample,most of the assetsthatcollateralize
studentloan asset-backedsecurities (SLABS) are federally guaranteed
pursuantto the Higher EducationAct of 1965. The status of securities
backed by mortgagesis a little murkier.The dominantissuers, Freddie
Mac andFannieMae, arenow privatelyowned entities.However,hardly

anyonebelieves the federalgovernmentwould standby idly in the event
of a systemic default by mortgagees in trust pools underlyingFederal
NationalMortgageAssociation (FNMA) or GeneralNationalMortgage
Association (GNMA) issues.
Derivatives enable institutionsto insure againstthe loss of (financial)
capitalby shiftingrisk to otherparties.For example, an institutionseek-
ing to hedge positions in stocks, commodities,currencies,or otherassets
may purchasean option to sell a marketbasket of stocks, commodities,
and so on, at a specified price at a specified future date. The value of
the option is ostensibly "derived"from the value of the underlyingas-
sets. The explosive growth of the derivatives trading since the 1980s
is usually explained by two factors: (1) the growing concentrationof
financialassets in professionally managedportfolios; and (2) develop-
ments in theoryof finance-most importantlythe Black-Scholes model
of options pricing.2
The most widely used device is the over-the-countercredit default
swap.3This is an arrangementwherebythe hedgingpartymakesperiodic
"coupon"paymentsto a counterpartythatis obligatedto makea payment
to the firstpartyin the event of a "creditevent"(for example,defaultor a
downgradeby ratingagencies), the size of the paymentbeing dependent
on the marketvalue of the "referenceassets"following the creditevent.4
Totalreturnswaps, or agreementsbetween two partiesto exchange the
totalreturnsfrom financialassets, is anothermeansby which agentsmay
insure againstprepayment,interestrate, or defaultrisk.5
Structuralchangein the lendingindustry

The financialinnovationsexplicated above have broughtforth a struc-
turaltransformationof the mortgage and consumerlending industries.
Table 1 reveals, for example, thatwhereasin 1976 traditionalmortgage
2 See Black and Scholes

(1973). For a discussion of the importanceof the Black-
Scholes theoremin the developmentof the securitiesindustry,see Rubinstein(1987).
3 For an explanationof differentcategories of derivatives,see Choudhry(2004).
4 Hedge funds were counterpartiesto derivativescontractsinsuringpositions in GM
and Ford Motor debt and sufferedmassive losses afterdowngradesby the ratingagen-
cies in May 2005. See Whitehouse(2005).
5
Prepaymentderivativeswere inventedin 2003. See Fabozzi (2005) for a descrip-
tion. FreddieMac (which has immense holding of "retained"MBSs-valued at ap-
proximately$1.5 trillion, or abouta quarterof the total outstanding,in 2005) is the
single largestuser of prepaymentderivatives.
Table 1
Mortgage debt outstanding by holder
Year
1976 1990
Amount Amount
(millions of Percent of (millionsof
Type of holder dollars) total dollars)
All holders 889,202 100.0 3,856,205
Commercial banks 151,326 17.0 843,136
Savings institutions 404,644 45.5 801,628
Lifeinsurance companies 91,555 10.3 267,335
Federal and related agencies 66,753 7.5 250,762
Mortgage pools or trusts 49,801 5.6 1,103,950
Individualsand others 125,123 14.1 638,172
Source:FederalReserveBulletin,tableB-72 (www.gpoaccess.gov/usbudget/fyo5/sheets/b76.xls)
lenders(commercialbanksand savings andloans) held a combined62.5

percentof mortgagedebtoutstandingon theirbooks, by 2004 theirshare
had fallen to 34.8 percent.The strikingfact is the sharpincrease in the
proportionof mortgagedebt held by "mortgagepools or trusts."
Figures1 and2 illustratethe growthof securitiesoutstandingcollateral-
ized by creditcard(revolving)andconsumerinstallment(nonrevolving)
receivables. Securities of this type have increased 20-fold since 1989.
Forty-twopercentof the growthof consumercreditoutstandingbetween
1989 and2005 is accountedfor by the growthofABSs. Sixty-twopercent
of the growthof revolvingcreditoutstandingsince 1989 is accountedfor
by securitiesbacked by nonrevolving(installment)receivables.
The Bond MarketAssociation reportedthat in September2005 the
value of ABSs outstandingwas $1.92 trillion. The breakdownby loan
category was as follows: $513 billion (or 26.7 percent of the total) of
outstandingABSs were collateralizedby home equity loans; $360.8 bil-
lion (18.8 percent)by creditcardreceivables;$226 billion (11.8 percent)
by auto loans; $139 billion (7.2 percent)by studentloans, and $683.8
billion (35.5 percent)by "other."6Bonds backed by mortgageand con-
sumerreceivablestogetheraccountedfor 32 percentof the bond market
in 2004, comparedto 27 percentfor U.S. governmentand agency debt
and 20 percentfor corporatedebt.7
Whenmortgageor consumerreceivablesareilliquid,the generalavail-
ability or "supply"of credit (or finance) is limited by the toleranceof
wealth holders (or controllers)for illiquidity.The securitizationof con-
sumerreceivablesremoves the constrainton the expansionof mortgage
or consumerlendingimposedby the generaldistasteof wealthcontrollers
for nontradableassets. By morphinginto securities,consumerdebtsgain
entranceto a vast new marketwhich at presentis (approximately)coex-
tensive with the aggregateof professionallymanagedpools of financial
assetsworldwide.8AssumingABSs accountedfor anunchangingfraction
of holdingsfor these units,growthof institutionalportfolioswould bring
6 "Other"includes loans for manufactured

housing and equipmentleases.
7 These
figureswere suppliedby the Bond MarketAssociation and were reportedby
Luchetti(2004).
8
Giddy writes that "securitisationissues are still difficultfor retail investorsto
understand.Hence most securitisationshave been privatelyplaced with professional
investors. However, it is likely that in [time] to come, retailinvestors could be attract-
ed to securitisedproducts"(http:absresearch.com, July 1, 2005).
FINANCIALENGINEERING,CONSUMERCREDIT,AND EFFECTIVEDEMAND 433
Figure 1 Asset-backedsecuritiesoutstandingfrom U.S. issuers

800 -
600-
05 400- / -. ,
0
200
90 92 94 96 98 00 02 04
Year
- --
|-Total Revolving Nonrevolving
Source:FederalReserveBoard(www.federalreserve.gov/releases).
Figure 2 Asset-backedsecuritiesas a percentof total consumercredit

outstanding in the United States
35
30-
25
20
15-
10-
0 i i i i I i I
90 92 94 96 98 00 02 04
Year
Source:FederalReserveBoard(www.federalreserve.gov/releases).
portfolioassetsin theUnitedStates(in trillionsof

Figure 3 Institutional
dollars)
200- , Insurance
Companies
Pension
Funds
Investment
Companies
Other
100-
50-
1985 1993 2001

Year
Source: OECD InstitutionalInvestorStatistics2003 (http://puck.sourceoecd.org).
forth a shifting demand for these instruments, ceteris paribus. The pro-
digious growth of financial asset pools under professional management
is a strikingdevelopmentof the past quartercentury.Financialassets of
"institutional investors" in Organisation for Economic Cooperation and
Development(OECD)countriesnearlydoubledin money termsbetween
1993 and 2001 (see Figure 3). The market value of assets held in U.S.
institutional portfolios increased by a staggering $102 trillion in the
same period,or 112 percent(see Figure4). It should also be pointedout
that the size of institutionalportfolios has increasedin relative as well
as absoluteterms.Thatis, the proportionof total intangibleassets under
professionalmanagementhas increasedmarkedly.Institutionsaccount
for the lion's shareof daily volume on bourses worldwide.
Althougha thoroughgoingtreatmentof the causes of institutionalport-
folio growthis not indicatedhere,a few key factorscanbe identified.9De-
mographicsare clearly important.The United States,Europe,andJapan
have recently seen bulging huddlesof postwarcohortsadvancethrough
9 See Brown (1998).
FINANCIALENGINEERING,CONSUMERCREDIT AND EFFECTIVE DEMAND 435
Figure 4 Institutionalportfolio assets of OECD countries(in trillions of

dollars)
400-
300-
0
o
100-
86 88 90 92 94 96 98 00
Year
Source: OECD InstitutionalInvestorStatistics 2003 (http://puck.sourceoecd.org).
the peak years of the earninglife cycle. Monthlyflows into pension and
mutualfunds have been resultantlyhigh. The EmploymentRetirement
Income SecurityAct (ERISA) of 1974 gave favorabletax treatmentto
funds committed to pension plans. (ERISA established the "defined
contribution"pension plan known as the 401(k).) The abolishmentof
fixed brokeragecommissions (i.e., brokers'fees set at a fixed industry
percentageof the value of transactions)by the Securitiesand Exchange
Commission in 1975 sharplyreducedtransactionscosts for institutions
and createdeconomies of scale in purchaseand sale of securities.
Financial engineering and effective demand:

a Post Keynesian interpretation
The argumentis made here that financialinnovationhas supplied a tre-
mendousstimulusto growthwhile at the same time makingthe economy
more susceptible to aggregate demand shocks. The beneficial impact
arises from thefunding effect of financialengineering-that is, its suc-
cess in expanding the reservoirof purchasingpower available to fund
large-scaleinvestment,new home construction,automobiles,university
educations, and other items.10The negative or destabilizingaspects of

the new regime are of two types: (1) speculativeor liquiditypreference
effects, and (2) balance sheet or Minskyeffects. The formereffect may
cause a constrictionof the availabilityof funding, whereas the latteris
capable of impingingon the supply or demandfor funding.
The nexus of financial engineering (or securitization) to effective
demand should be understoodin relation to a basic principle of Post
Keynesianthought:Navigatingin a social environmentthatis uncertain
or nonergodic-that is, that "outcomeson any specific futuredate [can-
not] be reliably predictedby a statistical analysis of past and current
marketdata"(Davidson, 2002, p. 51)-gives rise to the desire for stores
of value thatare liquid. In a nonergodic,transmutablereality,the future
is not merely unknown-it is unknowable.11Liquidityoffers a means of
deferringeconomic decision making,of "[evading]the consequencesof
such unknowledge"(Shackle, 1989, p. 49).
The fact that income is received in money-that is, in a form that
gives agents the power to withhold spending power from real sector
circulation-would seem to present a cripplingblow to the claim that
modem economies exhibit a naturaltendency to full employment.The
productionof liquid assets, in contrastto tangible but illiquid capital
goods, requiresa minimalemploymentof real resources.This factorex-
plains why liquiditypreferenceis capableof causing an insufficiencyof
effective demand.The low elasticity of substitutionbetween indivisible,
specializedcapitalgoods andmoney or marketablesecuritiesmeansthat
the accumulationof liquid claims to goods (saving) does not automati-
10 Post
Keynesiansdistinguishbetweenfinance andfunding. Finance refers to
comparativelyshort-termloans to productionunits (for example, farmers,building
contractors,or small business) needed to bridge the intervalbetween the disburse-
ment of factor cost and receipt of income from the sale of crops, new homes, or other
goods and services. Finance is mainly providedby depositoryinstitutions.Fundingis
usually defined as demandfor liquidityto purchaselong-lived, tangible assets, and is
accomplishedthroughthe issue of new securities.As will be discussed later,a signifi-
cant componentof the spendingpower createdby the issue of ABSs is used for the
purchaseof nondurableitems such as airlinetickets or hotel lodging.
1 Reality is transmutablewhen "futureeconomic outcomes may be permanently
changed in natureand substanceby today's actions of individualsor groups (for ex-
ample, unions, cartels, or governments),often in ways not perceivedby the creatorsof
change"(Davidson, 2002, p. 52).
cally result in the employment of economic resources to manufacture

tangible stores of value.12
The preferencefor liquidportfolioassetspresentsa formidableobstacle
to capital development.The main contributionof financialengineering
lay in transformingowners' or creditors'legal claims to futureincome
streamsof business enterprises(the balance sheets of which, after all,
consistmainlyof specializedcapitalgoods) into financialassetssalableat
low transactionscost in orderlysecondarymarkets.Securitizationmakes
commitmentsto producecapitalgoods thatare,fromthe collective point
of view, irrevocableneverthelessreversiblefor individuals.Securitization
and public ownership are innovationsthat relieve the tension between
liquiditypreferenceandthe staggeringcapitalrequirementsimposedby
modem productionmethods.13
The existenceof orderly,continuousspotmarketsfor previouslyissued
equities and bonds is a necessary condition for a high volume of new
issues, the proceeds of which supply the funding for investment.Does
it follow that financialengineeringexerts an unambiguouslybeneficial
effect on effective demand?Keynes noted that
[i]n the absenceof securitymarkets,thereis no objectin frequentlyat-
temptingto revaluean investmentto whichwe arecommitted.But the
StockExchangerevaluesmanyinvestments everydayandtherevaluations
a
give frequent opportunity to the (thoughnottothecommunity
individual
as a whole)to revisehis commitments....Butthedailyrevaluations of
theStockExchange,thoughtheyareprimarily madeto facilitatetransfers
of old investmentsbetweenone individualandanother,exerta decisive
influenceon therateof investment.(1936,p. 151)
Price movementsof existing securitiesare causally linked to the pace
of new issues (and, hence, investment)because (1) thereis near-perfect
substitutability betweenold andnew issues;and(2) (in matureeconomies,
at least) the flow of new issues (say, per month) is miniscule in relation
to the existing stock of sharesor bonds. Soaringvaluationsimprovethe
12 Davidson writes that

"[t]hebasic message of Keynes's GeneralTheory is thattoo
great a demandfor liquiditycan prevent 'saved' (thatis, unutilizedor involuntarily
unemployed)real resourcesfrom being employed to expandthe economy's productive
facilities" (Davidson, 2002, p. 10).
13 The
progressof secondarymarketsfor equities and bonds requiresa reliable legal
infrastructureto enforce fiduciarystandards,transparency,and debt covenants.The
institutionalprerequisitesfor viable securitiesindustriesappearto have been underes-
timatedby U.S. economic advisersto the Russian government,for example.
terms on which new issues can be floated off, whereas falling prices
heighten the risk that new offerings will be undersubscribed.14 Thus,
is of
speculation(or changing liquidity preference) capable perturbing
the scale of output and employment by virtue of the concatenationof
conditionsin primarymarketsto prices prevailingin secondarymarkets
for securities.15It is by this mechanismthat "bullishness"or "bearish-
ness" impinges on the real economy. Keynes wrote that "[t]hequestion
of the desirabilityof having a highly organizedmarketfor dealing with
debts [or equities] presentsus with a dilemma"(ibid., p. 172). On one
hand,the financialengineeringpaved the way for the rise to dominance
of large-scalebusiness organizations;but it left society more vulnerable
to shocksemanatingfromthe financialsector.However,the conventional
Keynesian view holds that changing liquiditypreference(connectedto
the speculativemotive) mainly affects business investment.Takinginto
account the structuralchanges in the mortgage and consumer lending
industriesdescribedin the precedingsection, have new channelsopened
up wherebychangingviews aboutanuncertainfutureconditiondecisions
to employ resources today? That is, has the emergence of secondary
marketsfor MBS and ABS created the opportunityfor speculation to
shock housing and consumergoods markets?
Balance sheet or "Minsky"effects
Hyman Minsky (see Minsky, 1986) claimed that a key determinantof
investment (and, hence, the demand for funding) is the relationship
between the firms' currentflow of receipts from operationsand their
"liability structures"-that is, contractualobligations to pay interest
andprincipalon existing debt. Minky's cash flow-debt principlecan be
extended to consumptionif (1) households carrysubstantialdebts, and
(2) a nontrivialshareof householdpurchasesare fundedby the issue of
IOUs. Under these conditions, the growth of consumptionexpenditure
dependspartlyon the willingness of householdsto layer balance sheets
14 The sharpdecrease in initial public offering (IPO) volume following the dot-com
crash provides an excellent recent example.
15The term
rising liquiditypreferenceconnotes a general increasein the desire for
assets thatprovide insuranceagainstwhat Robinson called "capitaluncertainty"or
potentialloss of (financial)capital due to interestrate or shareprice fluctuations(see
Robinson, 1979, p. 138). Rising liquiditypreferencedescribes a "flightto safety"or a
shift into asset groupscharacterizedby low capitaluncertainty.Includedamong these
is money properbut also near-moniessuch as commercialpaperand short-dated,gilt-
edged securities.For a reexaminationof liquiditypreference,see Brown (2004).
with additionaldebt obligationsandpartlyon the readinessof consumer

lendingagenciesto accommodatecreditdemand.The willingnessto bor-
row or lend is, in turn,conditionedby the sufficiency (or lack thereof)
of currentincome with respect to debt service.
Minsky developed the following taxonomy for borrowingunits:
1. Hedge units: Cash receipts (or income) are sufficient to repay
interestand principal.
2. Speculative units: Cash receipts (or income) are adequateto re-
pay interestbut not principal.These units must roll over existing
debts.
3. Ponzi units: Cash receipts (or income) are insufficientto repay
interest or principal.Ponzi units must add debts (or sell assets)
merely to pay intereston existing debt obligations.
The "financial instability" hypothesis posits a tendency to decay of
overall balancesheet qualityin the course of business cycle expansions.
A boom underpinnedby debt must inevitably result in the migrationof
many spendingunits from "hedge"to "speculative"and "Ponzi"status.
Widespreadfinancialdeteriorationmay precipitatean episode of what
Minsky termeddebt deflation.Debt deflationis potentiallycatastrophic
because (1) it chokes off new borrowingto financespendingfor tangible,
reproduciblethings (such as producerandconsumerdurables);and(2) it
entails a massive redirectionof income flows from productmarketsto
debt servicing.The severity of economic contractionsis intensifiedas a
consequence of this process of balance sheet adjustment.
The following is the main question of interesthere: Has financialen-
gineering increased the risk of debt deflationby easing the borrowing
constraintfaced by the household sector?Applying the Minskianlogic
to the household sector,we may hypothesizethatthe likelihood of debt
deflationis directly proportionalto the fractionof households that at a
particularpoint in time can be classified as speculative or Ponzi units.
Thus, financialengineeringmay be said to be harmfulif its effect is to
diminish the share of consumersthat practicehedge finance-an issue
taken up in the following section.
Fundingeffectsand consumption
A primary effect of the securitization of mortgage and consumer
receivables is to boost the borrowing power of households situated
across a wide bandof the income scale. Cross-sectionaldatareveal that
spending-income ratios tend to be higherfor lower-incomehouseholds
and vice versa-that is, the marginalpropensityto consume out of the

marginalincrementof incomeis (on average)diminishing.Thus,widened
credit availability has an effect comparableto that of reduced income
inequality-that is, it makesthe aggregatepropensityto consumehigher
than it would be otherwise.16
If the thesis articulatedabove is correct, the consumptionfunctions
should exhibit structuralinstability-that is, regressioncoefficients for
the pre-ABS era shouldbe differentthanthose for the post-ABS era.To
examine this question, an ordinaryleast squaresestimation of a stan-
dard consumptionmodel was performedusing monthly U.S. data for
1972-2005. The model posits consumption(C) as a functionof personal
disposable income (DY), wealth as estimated by the opening monthly
value of the Standardand Poor's Index of 500 stocks (SP), and interest
ratesas measuredby the averagerateof interestchargedon loans issued
by automobilefinancecompanies(r). C andDYaremeasuredin billions
of dollarsat seasonally adjusted,annualrates.The datawere partitioned
into two subsamples-one set for the pre-ABS era (January1972 to
December 1987) and anotherfor post-1988 (see estimatesin Table2). In
technicalterms,the structuralrelationshipsbetweentime seriesvariables
are stable if the subsets of coefficients are equal. The estimatesreported
above show substantialdifferences.Results of a Chow "breakpoint"test
are displayedin Table 3 (see Chow, 1960). The F-statisticis used to test
the null hypothesisthatboth samplesbelong to the sameregression-that
is, the coefficients are not time varying. The hypothesis of structural
stabilitycan be rejectedat the 0.001 level.
The presence of structuralinstability is not by itself sufficient to
establish the importanceof ABS-related funding effects. The case for
funding effects would be strengthenedif it could be shown that (post-
1987) (1) manyhouseholdshave experiencedan increasein theirability
to obtaincreditfor reasonsunrelatedto theircreditworthiness;and (2) a
sufficient numberof households have availed themselves of expanded
options to borrow such that the growth of aggregateconsumptionhas
come to be increasinglycreditdriven.Withrespectto (1) above, an indi-
16
This argumentis developed at length in Brown (2004). With respectto the con-
nection between distributionand the propensityto consume, Keynes statedthat
"[s]ince I regardthe propensityto consume as being (normally)as such to have a
wider gap between income and consumptionas income increases, it naturallyfollows
that the collective propensityfor the communityas a whole may depend ... on the
distributionof incomes within it" (Keynes, 1939, p. 129).
Table 2
Least squares estimates of consumption specifications using monthly
U.S. data
Sample
1972-1987 1987-2005
Variable (n = 193) (n = 214)
Constant 60.7668 -663.18

(2.988) (-9.898)
DY 0.8501 1.0264
(163.530) (133.205)
SP 0.4723 -0.0220
(5.366) (-0.962)
r -5.3724 9.5379
(-3.990) (2.836)
Adjusted R2 0.999 0.999
t-statisticsareshownin parentheses.
Table 3
Chow breakpoint test (breakpoint is December 1987)
F-statistic 143.484 Probability 0.000000

Log likelihoodratio 362.492 Probability 0.000000
vidual may find his or her borrowingpower augmentedas a result of an

increasein his or herincome, lengthof employment,or a changein other
factors weighed in credit scoring algorithms.The term expandedcredit
availabilitydescribesa differentphenomenon-specifically, the secularly
enlargedborrowingopportunitiesof a person with a given credit score.
Financial engineering boosts aggregate demand because it effectively
raises the maximum amountthat could be borrowedby households at
virtuallyevery tier of the creditworthinesshierarchy.
What empirical evidence is available to verify the hypothesis of ex-
pandedcreditavailabilityin the post-1987 United States?The tri-annual
Surveyof ConsumerFinances(SCF;www.federalreserve.gov/pubs/oss/
oss2/scfindex.html)providesinformationaboutmanyfinancialvariables
for a sample of approximately22,000 U.S. households. By employing
sampleweights, it is possible to drawinferencesaboutkey measuresfor
the U.S. population.Two questionscontainedin the surveyarerelevantto
the issue of credit availability.Respondentsare asked to list the number
of Visa, Mastercard,Discovery, and Optima card accounts they have
open. Also, respondentsreportthe combinedcreditlimit they have been
extended by issuers of these cards. Evidence about credit availability

may be found by examining changes over time in the average number
of credit cards held and credit limits of households in the same income
categories.The informationin Table4 comes from microdataextracted
from the SCF of the years 1989, 1995, 2001, and 2004.17The income
levels selected are $5,000 ranges at the center of income quintiles for
the year 2004.18Thus, the bracketrangingfrom $41,727 to $46,727 is
located in the thirdquintileand extends acrossthe midpointof the 2004
distribution.It should be noted that the variables "averagenumberof
creditcards"and "averagecreditlimit"figurein householdsthatdo not
carrythese creditcards.The changein creditavailabilityin the post-ABS
era, at least as measuredby the percentageincreasein the averagecredit
limit of a household within a given (narrow)income bracket,is most
strikingfor low- and middle-incomehouseholds.Observethatthe aver-
age combined credit limit on Visa, Mastercard,Discovery, and Optima
card accounts for the income range $6,750-$11,750 (bottom quintile)
rose to $3,590 in 2004 from a value of $854 in 1989-an increase of
320 percent. Those in the $23,492-$28,492 bracket saw their credit
limits expandby $5,022 or 177 percent.It should not be surprisingthat,
in absolute terms, high-income families saw the greatestexpansion in
borrowingpower.
Precisely how does financialengineeringmake crediteasier to obtain
for low-income households?Note that securitizationis a techniquefor
achieving diversification.The collateral for an ABS consists of many
thousandsof comparativelysmallloans andthusis "granular"-meaning
no largeexposureto a single borrower.The granularityof ABS collateral,
combined with the fact thatmany low-income individualsare prepared
to pay dearlyto obtaincredit,eases the difficultywith which loan origi-
nators may bundle high-risk loans with better-qualityreceivables for
transferto SPVs.
There is no disputingthe fact that a vast numberof individualshave
converted aggrandizedborrowing privileges into spending for goods
and services. The evidence takes the form of aggregate-leveldataon the
time path household debt outstanding(in absoluteterms and relative to
17The
survey questions regardingnumberof Visas, Mastercards,and so on, as well
as combined credit limits on those accountswas includedfor the firsttime in the 1989
SCF.
18These data were obtainedfrom the U.S. Census BureauHistoricalIncome Tables
and can be found at www.census.gov/hhes/www/income/histinc/inchhtoc.html.
Table 4
Average number of credit cards, average total credit limit by income level, selected
Year
1989 1995
Average Average Avera

number of Average number of Average numbe
credit credit credit credit credi
Income range cards limit cards limit cards
$6,750-$11,750 0.078 $854 0.488 $1,876 0.538

$23,492-$28,492 0.565 $2,835 1.194 $5,861 1.244
$41,727-$46,727 0.967 $5,175 1.667 $10,757 1.810
$68,160-$73,160 1.133 $9,936 2.270 $15,368 2.056
$120,107-$125,107 1.561 $14,644 2.732 $23,190 2.030
Source:Author'scalculationsfromthe Surveyof ConsumerFinances.
Notes:Averagenumberof creditcardsis the averagenumberof Visa, Mastercard,Discovery,andOp
combinedtotalcreditlines on aforementionedaccounts.
Figure 5 Ratio of consumercredit outstandingto consumption

0.26-
0.24-
0.22-
0.208
0.18-
0.16- , , , , , , , , , , , , , , , , , , , , , . . .
78 80 82 84 86 88 90 92 94 96 98 00 02 04
YearMlonth
Source: FederalReserve Board (www.federalreserve.gov/releases)and Bureauof

Economic Analysis (http://bea.gov).
Note: Recessions are shaded.
Figure 6 Household debt-to-incomeratios in the United States

1.6-
1.4
1.2 -
1.0- ,!
0.8 -
0.6-
75 80 85 90 95 00 05
Year
Mortgagedebt only ---- Totaldebt
Source: Economic Report of the President (www.gpoaccess.gov/eop/index.htm).
income and consumption;see Figures 5 and 6). Furtherverificationis

providedby public access micro data pertainingto the statusof house-
hold balance sheets.
Much has been made of the decreasein the saving rate of U.S. house-
holds (it fell from 15 to near0 percentbetween 1985 and 2005). This is
a surprisingdevelopmentin light of the rathersharpincreasein income
inequality that occurredin the United States during the period.19The
theoremthat,ceteris paribus,the propensityto consume is a decreasing
functionof inequalityis implicitly based on the assumptionthatincome
exertsa "hard"constrainton consumption.Thepracticaleffect of widened
and deepenedcredit availabilityis to soften the budget constraint-that
is, to free spending from the discipline imposed by currentincome.
Viewed in a Veblenianlight (see Veblen, 1898), borrowingis an expedi-
ent by which individualsare able to maintaintheir consumptionstatus
vis-a-vis other social classes in the face of rising income disparities.20
The softening of budget constraintshas importantimplications with
respect to the time path of the saving rate. Specifically,the saving rate
has declined mainly due to substantialcross-sectionalchanges in sav-
ing-income ratios. The prevalence of deficit spending is much greater
today than 15 years ago. Moreover,the incidence of deficit spendingis
much higher for families in the bottom half of the income distribution.
These factors taken together lead to the conclusion that consumption
expenditureis appreciablymore credit dependentthan a cursory look
at the statistics would suggest. Aggregate debt-to-incomeratios do not
reveal the underlying distributionof debt and income. If, over time,
increases in income accrue disproportionatelyto wealthy individuals,
and increases in debt are disproportionatelydistributedto the balance
sheets of lower-income,deficit-spendingunits, then the aggregatedebt-
to-income ratiocan remainroughly constanteven when a greatershare
of consumptionexpenditureis debt financed.
19The U.S. Census Bureaureportsthatthe Gini ratiofor household (market)income

increasedevery year after 1981 (from 0.403 to 0.496 in 2004). These data are taken
from the U.S. Census BureauHistoricalIncome Tables,E-6 (www.census.gov/hhes/
www/income/histinc/ineqtoc.html).
20
Bob Davis of the WallStreetJournalreportedthat "[m]oreand more Americans
are turningto debt for lifestyles theircurrentincome cannot support.They are deter-
mined to live a betterlife than theirparents,seduced by TV shows like 'The O.C.' and
'DesperateHousewives' which take upper-classlife for granted,and bombardedwith
advertisementsfor expensive automobilesand big-screenTVs.... For Americans
who aren'tgetting a big boost from e workplaceraises, easy creditoffers a way to get
ahead, at least for the moment"(2005, p. Al).
Muchhasbeen writtenaboutthe importanceof home priceappreciation

in explaining the recent consumer spendingboom. Two points need to
be raisedhere.First,takinginto accountthe relativelyinelastic supplyof
owner-occupiedhousing, a sharpincreasein the availabilityof mortgage
financeis capableof generatingsubstantialupwardpressureon realestate
values. Second, escalatingreal estate values have the potentialto boost
consumer spending mainly to the degree that homeowners are able to
convert their hypotheticalnew wealth to spendingpower. Whereasthe
MBS has been instrumentalin enlargingthe pool of mortgage money
and holding down its price, the ABS has effectively made home equity
a more liquid asset.
A largenumberof variablesdrivehome prices. However,the evidence
suggests thatcheap, widely availablemortgagemoney may be the most
importantfactor in explaining rising home prices in the past 10 to 15
years.As was noted earlier,the MBS is an instrumentthattrimsfunding
costs by giving holdersdiversificationacrossa largenumberof mortgage
borrowers.Also, the de facto federal guaranteecarriedby Ginnie Mae
and FreddieMac makes their yields (and thus mortgage interestrates)
lower thanthey would be otherwise.The phenomenalgrowthof demand
for MBSs in the past decade swelled the ranksof home buyers.It also in-
creasedthe averageamountthatmortgageborrowerscould qualifyfor.21
These developments produced a consequentialmarket externality-a
massiverise in the estimatedvalue of home equityavailableto be "cashed
out."Althougha few householdsmay be able to accomplishthis through
the sale of theirhomes, a generalizedmovementto realize or "lock-in"
real estate capital gains throughthe sale of propertyis subject to the
fallacy of composition.
Lookingback,it is difficultto imaginehow new productssuch as home
computers,DVD players,flat screenTVs, MP3 players,digitalcameras,
or SUVs could have achieved such stunninglevels of marketpenetra-
tion duringthe past several years sans financialengineering.Moreover,
21 The WallStreetJournal
reportedthat "[i]nvestor'sstrongdemandfor mortgage
debt, besides allowing lenders to offer many borrowersbetterterms,has also made it
easier to offer mortgagesto borrowerswho might not easily qualify for a loan. The
growth of mortgagemarketsspreadsthe risk around.But some mortgage-industry
analysts say lendershave become less stringentin theirloans termsbecause they can
sell almost any type of loan to those who package mortgagesecuritiesto investors"
(Simon et al., 2005, p. Al).
ABS-relatedfunding effects have contributedto the U.S. importboom

and currentaccountdeficits.
Evidenceof Minskyeffects
By selling theirIOUs, householdsarepledginga streamof futureincome
in exchange for spending power today. Thus, consumer finance effec-
tively shifts spending from the futureto the present.But debt-financed
spendinghas obvious balance sheet consequences or what were earlier
termed Minskyeffects. Thus, the question arises: To what degree is a
debt-bolsteredconsumerspendingboom sustainable?
The purpose of this section is to assess the implicationsof financial
engineering for the quality of household balance sheets in the United
States. Precisely, we are interestedin statistics that trackchanges over
time in the capacityto service debt obligations.It is not possible (at least
withoutarbitraryassumptions)to give precise estimatesof the distribu-
tion of householdunits in a given year between the categoriesof hedge,
speculative, and Ponzi finance. There are statistics that enable one to
make reasonable inferences about the general direction and sinew of
movement among these divisions.
The debt service ratiois the FederalReserve's estimateof the required
minimum payment on consumer borrowing. It is determined by the
amountof debt outstanding(excludinghome equity andmortgagedebt)
and hire-purchaseterms (payment schedules, interest rates, and other
fees). The financialobligationsratioaddsotherconsumerobligations(au-
tomobile lease payments,rentalpaymentson tenant-occupiedproperty,
homeowners'insurance,and propertytax payments)to the debt service
ratio. The decline of these time series after 1986 is partlyexplainedby
the substitutionof home equity loans for conventionalconsumerloans
after the eliminationof the tax deductibilityof interestpaid on the lat-
ter type of debt. But the recordshows a more or less uninterruptedrise
in these ratios between 1994 and 2002, followed by a brief moderation
andthen anothersurgebeginningin the fall of 2003 (see Figure7). Both
indicatorsare presentlynear their peak levels, and well above historic
averages. The behavior of these variables certainly does not serve to
falsify the hypothesis that a large cohort of families is more financially
distressed today than 10 years ago. The debt service and financialob-
ligations ratios are neverthelessof limited usefulness for our purposes.
For one thing, they omit home equity debt. Second, they are aggregate
ratios and thus give no informationaboutthe underlyingdistributionof
debt or income across households. As was mentionedearlier,the time
Figure 7 Debt service and financialobligations ratio (percent)

19
14- I'"'
/.1 -18
17
16
15
-
10 I I I I I I I I I I I I ... ..I I. . .X
IIX I. I I{
80 82 84 86 88 90 92 94 96 98 00 02 04
Year/Quarter
Debt Service ratio ---- FinancialObligationsRatio
Source: FederalReserve Board (www.federalreserve.gov/releases).
path of these aggregate ratios can be misleading if increases in income

and debt are distributed unevenly across income groups.
Microdata extracted from the SCF were used to compute mean debt-
to-income ratios by income quintile (as well as the top 5 percent) for the
years 1983, 1989, 1995, 2001, and 2005. These are displayed in Table
5. Note that debt includes credit card debt, installment loans, personal
loans, student loans, and home equity loans. It does not include mortgage
debt. The overall debt-to-income ratio reached 0.304 in 2004. It was
equal to 0.181 in 1983. Probably the most striking aspect of Table 5 is
the large increase in the debt-to-income ratios of the bottom two quintiles
between 1989 and 2004. These figures support the view that financial
engineering has exerted a powerful effect on the spending behavior of
low- and middle-income groups especially. Sadly, these are the units
most vulnerable to financial ruin as a result of borrowing.
Even within income quintiles, debt and income are distributed un-
equally. Every income strata includes a slice of households (mainly
older) that are conservative in their use of credit. Thus, a matriculation
of units from hedge to speculative or Ponzi status might be uncovered
by measuring the proportion of households with debt-to-income ratios
exceeding some threshold level.
Table 5
Debt-to-income ratios by quintile
Year
Quintile 1983 1989 1995 2001 2004
Bottom 0.384 0.236 0.291 0.491 0.427

Second 0.153 0.179 0.200 0.258 0.354
Middle 0.150 0.239 0.180 0.250 0.282
Fourth 0.140 0.221 0.160 0.206 0.260
Top 0.138 0.178 0.092 0.140 0.145
Top 5 percent 0.126 0.201 0.047 0.107 0.088
All 0.181 0.215 0.192 0.264 0.304
Source:Author'scalculationsfromthe Surveyof ConsumerFinances.
Note:Debtincludesconsumerandhomeequitydebt.
Table 6 provides estimates for various years of the fractionof house-

holds withinincomequintiles(andthe top 5 percent)withdebt-to-income
ratiosexceeding 0.4 and0.6. Note thatfor the entirepopulation,slightly
more than 10 percent had debt-to-incomeratios greaterthan 0.4. The
numberwas 12.4 percentin 1995 and then rose to 23.2 percentin 2004.
Note also that debt-to-incomeratios for the top quintile and top 5 per-
cent actually decreasedin the same period.This is not surprisinggiven
that the top quintile (and top 5 percent) saw its share of total income
increase from 44.7 to 50.1 (16.4 to 22.4) percentfrom 1983 to 2001.22
The story is much differentfor the remaining80 percentof households,
and especially the bottom two quintiles. Notice, for example, that the
proportionof units within the lowest quintile with a debt-to-incomera-
tio exceeding 0.4 rose from 14.5 to 40 percentbetween 1995 and 2004.
Notice also that while approximately9 percentof second quintileunits
had debt-income ratios in excess of 0.6 in 1995, the comparablefigure
in 2004 was 26.2 percent.In summary,the evidence of Minsky effects
relatedto financialengineeringis quite overwhelming.Moreover,it is
highly questionableas to whetherthe pace of borrowing(andconsumer
spending) achieved in the past decade can be sustainedin light of the
deteriorationof householdbalance sheets.
As was noted earlier, Minsky effects can induce a decrease in the
supply or demandfor credit card, installment,student,or home equity
22These data were takenfrom the U.S. Census BureauHistorical

Income Tables,
IE-3 (www.census.gov/hhes/www/income/histinc/inchhtoc.html).
Table 6
Proportion of households with debt-to-income ratios exceeding 0.4 and 0.6, by qu
Year
1983 1989 1995
Quintile >0.4 >0.6 >0.4 >0.6 >0.4 >0.6
Bottom 0.124 0.088 0.164 0.118 0.145 0.118

Second 0.110 0.056 0.137 0.074 0.173 0.088
Middle 0.096 0.045 0.207 0.109 0.140 0.058
Fourth 0.082 0.042 0.169 0.085 0.106 0.044
Top 0.095 0.052 0.075 0.037 0.036 0.007
Top 5 percent 0.106 0.053 0.081 0.033 0.016 0.003
All 0.102 0.057 0.164 0.118 0.124 0.065
Source: Author's calculations from the Survey of Consumer Finances.
loans. One consequence of the developments highlighted in Tables 5

and 6 is an increase in lenders'risk. The likelihood of defaultis mainly
regulatedby the sufficiencyof income flows in relationto debt servicing
requirements.A systemic rise in debt-income ratios must thereforebe
accompaniedby falling credit scores (and, hence, decreased access to
credit)for a greatnumberof individuals.Balance sheet degradationalso
means a rise in bankruptcy-related charge-offsfor lenders.23A standard
reactionis to toughencreditstandards.Koreafurnishesa recentexample
of this phenomenon.24
Minsky effects also heightenthe risk of householddebt deflation-the
termused to describea suddenandpervasiveeffortby consumersto re-
duce the shareof currentincome flows claimed by debt servicing.Debt
deflationhas two dimensions-both of which arepotentiallydeleterious
with respect to effective demand. First, debt deflation brings about a
sharpcontractionin the pace of creditexpansionandhence debt-financed
expenditure.Second, households,in the shortrun,may actuallyincrease
the share of income allocatedto debt servicing or retirement.The U.S.
recordrevealsan increasein the ratioof repaymentsto existingconsumer
debt in 1930, 1980, and 1990 (all recession years).25The borrowing
binge of the past 10 yearshas left a plethoraof householdsin a weakened
financialstate, andmade the prospectfor debt deflationa nearcertainty.
It is likely not a matterof if, but only when.
Concludingremarks
Hamiltonwrote:
Oneof thedifficulties
intheindustrial
economyis thefailureof itsceremo-
nialsystemof distribution,
basedonimputedproductivities,
toredistribute
23
Standard& Poor's Rating Groupreported500,000 bankruptcies(30 times the
normalamount)filed three weeks priorto the deadlinefor new U.S. bankruptcylaw to
take effect October2005. See Mollenkamp(2006).
24
The Economistreportedin 2004 that "SouthKorea'sconsumersare still suffering
a financialhangoverfrom a credit-cardborrowingbinge, but the banksthat encour-
aged them are recovering.Weigheddown by bad consumerdebts, theirearningsfell
63 percentlast year"("HangoverCurve,"2004).
25
For example, I estimatedthat the ratio of "voluntary"repayments(repayments
in excess of the minimumrequiredto remainin compliance with the terms of hire
purchasecontracts)to "total"repaymentson consumerdebt increasedfrom 0.312 to
0.435 between July 1929 and March 1930 (see Brown, 1997, especially p. 632, table
2). The firsthalf of 1980 saw a very steep decline in "revolving"use of creditcards
(see Brown, 1993, p. 123, table 6-3).
sufficientlyto keepthereciprocalflowof goodsandmoneyat a constant

or increasingrate.It is preciselythis aspectof the industrialsystemto
whichJ.M.Keynesaddressedhimself.(1991,pp.944-945)
Maldistributionis the root cause of the (paradoxical)disparitybetween
society's physical capacity to deliver goods and the ability of many of
its membersto affordthem.A maintheme developed in this paperis that
the puissance of the U.S. consumer amid growing income inequality,
decreasedjob security,and the wholesale offshoring of jobs that once
provideddecentlivelihoods is testamentto the achievementsof financial
engineering. Improvedcredit availability(as defined above) has made
it possible for families of comparativelymodest means to own home
computersor send their childrento college. The innovationsdescribed
in the precedingpages have also assumeda key role in the maintenance
of expenditureflows requiredto validatemarketvaluationsof corporate
equities.
Another argumentpursued above is that the costs to society related
to financialengineering are substantialand requirefurtheranalysis by
economists andpolicy makers.The debt-financedconsumptionboom of
the late 1990s andearly 2000s is a materialfactorunderpinningthe U.S.
merchandisetradedeficit.It has also createdthe illusion thatthe hollow-
ing out of the income distributionfunction need not have detrimental
macroeconomicconsequences.Innovationssuch as the MBS orABS do
not solve the problem of the insufficiency of effective demand-they
merely postpone it.
REFERENCES
Black, F., and Scholes, M. "ThePricingof Options and CorporateLiabilities."Journal
of Political Economy,May-June 1973, 81 (2), 637-659.
Brown, C. Moneyand ConsumerDurable Spending.New York:Garland,1993.
. "ConsumerCreditand the Propensityto Consume:Evidence from 1930."
Journal of Post KeynesianEconomics, Summer 1997, 19 (4), 617-638.
. "Rise of the InstitutionalEquityFunds:Implicationsfor Managerialism."
Journal of EconomicIssues, September1998, 32 (3), 803-821.
---- . "Does Income DistributionMatterfor Effective Demand?Evidence from the
United States."Reviewof Political Economy,July 2004, 16 ( 3), 291-307.
Choudhry,M. StructuredCreditProducts: CreditDerivatives and SyntheticSecuriti-
sation. Hoboken,NJ: Wiley, 2004.
Chow, G. "Testsof EqualityBetween Two Sets of Coefficients in Two LinearRegres-
sions." Econometrica,July 1960, 28 (3), 591-605.
Davidson, P. Financial Markets,Money,and the Real World.Northampton,MA:
EdwardElgar,2002.
Davis, B. "LaggingBehind the Wealthy,Many Keep Up by Borrowing."WallStreet
Journal, Easternedition, May 17, 2005, Al.
Fabozzi, F. "TheStructureFinanceMarket:An Investor'sPerspective."Financial

AnalystsJournal,May-June 2005, 61 (3), 27-41.
Giddy,I. "New Developments in Asset-Backed Securities."ABS Research.com.New
York,July 1, 2005 (available at http://giddy.org/abs-jhb.htm).
Hamilton,D. "TheMeaningof Anthropologyin Economics."Journalof Economic
Issues, December 1991, 25 (4), 937-949.
"HangoverCure:The Aftermathof the ConsumerBorrowersBinge." Economist(June
5, 2004), 71.
Keynes, J.M. The General Theoryof Employment,Interestand Money.London:Mac-
millan, 1936.
. "Mr.Keynes on the Distributionof Incomes and the 'Propensityto Con-
sume': A Reply."Review of Economicsand Statistics,August 1939, 21 (3), 129.
Lee, S. "FreddieHides in the Hedges." WallStreetJournal,Easternedition, July 15,
2003, A15.
Luchetti,A. "IndebtedConsumersReshape the Bond Market."WallStreetJournal,
Easternedition, September14, 2004, C1.
Minsky, H. Stabilizingan UnstableEconomy.New Haven:Yale UniversityPress,
1986.
Mollenkamp,C. "BritishBanks:Time to Bet or Bail Out?"WallStreetJournal,East-
ern edition, February22, 2006, C1.
Robinson,J. The Generalizationof the General Theory.New York:St. Martin'sPress,
1979.
Rubinstein,M. "DerivativeAsset Analysis."Journal of EconomicPerspectives,Fall
1987, 1 (2), 73-93.
Schwartz,S. "TheAlchemy of Asset Securitization."StanfordJournalof Law,Busi-
ness, and Finance, Fall 1994, 1 (2), 133-153.
Shackle, G. "WhatDid the General TheoryDo?" In John Pheby (ed.), New Directions
in Post-KeynesianEconomics.Aldershot,UK: EdwardElgar, 1989, pp. 48-58.
Simon, R.; Hagerty,J.R.; andAreddy,J.T. "Housing-BubbleTalkDoesn't Scare Off
Foreigners;Global InvestorsGobble Up Mortgage-BackedSecurities,Keeping Prices
Strong."WallStreetJournal,Easternedition, August 24, 2005, Al.
Veblen,T. Theoryof the Leisure Class. New York:Penguin, 1898 [1979].
Whitehouse,M. "How a FormulaIgnited a MarketThat BurnedInvestors."Wall
StreetJournal,Easternedition, September12, 2005, Al.

Taylor & Francis, Ltd. Is Collaborating With JSTOR To Digitize, Preserve and Extend Access To Journal of Post Keynesian Economics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Taylor & Francis, Ltd. Is Collaborating With JSTOR To Digitize, Preserve and Extend Access To Journal of Post Keynesian Economics

Uploaded by

Copyright:

Available Formats

Financial Engineering, Consumer Credit, and the Stability of Effective Demand

Author(s): Christopher Brown

or educationalloans, is there a nascentthreatof instabilityarisingfrom

Schwartzexplains that "[a] securitizationtransactioncan provide obvious cost

the same as for corporateequities or municipal bonds. A prospectus

TheABS markethas been buttressedby strongdemandin the past sev-

Mac andFannieMae, arenow privatelyowned entities.However,hardly

Structuralchangein the lendingindustry

2 See Black and Scholes

lenders(commercialbanksand savings andloans) held a combined62.5

6 "Other"includes loans for manufactured

Figure 1 Asset-backedsecuritiesoutstandingfrom U.S. issuers

Figure 2 Asset-backedsecuritiesas a percentof total consumercredit

portfolioassetsin theUnitedStates(in trillionsof

1985 1993 2001

9 See Brown (1998).

Figure 4 Institutionalportfolio assets of OECD countries(in trillions of

Source: OECD InstitutionalInvestorStatistics 2003 (http://puck.sourceoecd.org).

Financial engineering and effective demand:

educations, and other items.10The negative or destabilizingaspects of

cally result in the employment of economic resources to manufacture

12 Davidson writes that

with additionaldebt obligationsandpartlyon the readinessof consumer

and vice versa-that is, the marginalpropensityto consume out of the

Constant 60.7668 -663.18

F-statistic 143.484 Probability 0.000000

vidual may find his or her borrowingpower augmentedas a result of an

extended by issuers of these cards. Evidence about credit availability

Average Average Avera

$6,750-$11,750 0.078 $854 0.488 $1,876 0.538

Figure 5 Ratio of consumercredit outstandingto consumption

Source: FederalReserve Board (www.federalreserve.gov/releases)and Bureauof

Figure 6 Household debt-to-incomeratios in the United States

income and consumption;see Figures 5 and 6). Furtherverificationis

19The U.S. Census Bureaureportsthatthe Gini ratiofor household (market)income

Muchhasbeen writtenaboutthe importanceof home priceappreciation

ABS-relatedfunding effects have contributedto the U.S. importboom

Figure 7 Debt service and financialobligations ratio (percent)

path of these aggregate ratios can be misleading if increases in income

Quintile 1983 1989 1995 2001 2004

Bottom 0.384 0.236 0.291 0.491 0.427

Table 6 provides estimates for various years of the fractionof house-

22These data were takenfrom the U.S. Census BureauHistorical

1983 1989 1995

Quintile >0.4 >0.6 >0.4 >0.6 >0.4 >0.6

Bottom 0.124 0.088 0.164 0.118 0.145 0.118

loans. One consequence of the developments highlighted in Tables 5

sufficientlyto keepthereciprocalflowof goodsandmoneyat a constant

Fabozzi, F. "TheStructureFinanceMarket:An Investor'sPerspective."Financial

You might also like