Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens, by Antonio Coppola, Matteo Maggiori, Jesse Schreger, and Brent Neiman:
We start with the dataset of global mutual fund and exchange traded fund (ETF) holdings provided by Morningstar and assembled in Matteo Maggiori, Brent Neiman and Jesse Schreger (2019a, henceforth MNS). For each position in the data, we link the security’s immediate issuer to its ultimate parent. The resulting data can then be used to create a mapping that transforms cross-border positions from a residency to nationality basis and that sheds light on how global firms finance themselves. …
First, in the case of bonds, positions are almost always reallocated away from Bermuda, the Cayman Islands, and other tax havens. Under nationality, these positions are often associated with developing countries like Brazil, China, India, and Russia, which may reflect the fact that developing countries find it easier to issue offshore than onshore, where the legal system and institutional quality may be of concern to foreign investors. Reallocating positions from tax havens to developed countries is also common, though, perhaps because tax havens allow them to access international investors with less onerous rules governing the withholding of taxes on interest payments. These patterns may also reflect tax-driven profit-shifting, whereby one unit of a company raises money at a low interest rate in a low-tax regime and loans it at a higher interest rate to an affiliated unit in a high-tax regime.
Second, in the case of equities, we find that many developed-country investments in tax havens are actually associated under nationality with China. Many of these positions are in securities issued through Variable Interest Entities (VIE), a structure designed to avoid China’s capital controls and the legality of which may rest on tenuous ground. Relatedly, we see a large share of equities reallocated by our algorithm away from Ireland and to developed countries, an adjustment reflecting the popularity of “tax inversions” there.
Third, in the case of asset-backed securities, for several investor countries, we find large reallocations toward the domicile of the investor, often because the underlying assets are found there. For example, our reallocation matrix records that 73.4 percent of U.S. investment in Cayman Islands’ asset-backed securities should instead be thought of as U.S. domestic investment, largely because those securities are backed by U.S. mortgages.
Der Bund. March 5, 2019. HTML.
Short newspaper interview about corrective taxes, tackling problems at the root, and equity vs. efficiency.
In the FT, Jamie Smyth reports that the Australian Securities Exchange plans to introduce a blockchain based equity clearing and settlement system.
ASX will operate the system on a secure private network with known participants. The participants must comply with regulation, according to the ASX, which said its system had nothing to do with blockchain technology deployed by cryptocurrencies such as bitcoin.
On his blog, John Cochrane argues that banks could, and should be 100% equity financed. His points are:
(1) There are plenty of safe assets—government debt—out there and banks do not need to “create” additional safe assets—deposits.
I share this view partly. First, I don’t know what amount of safe assets are sufficient from a social point of view. Second, I don’t consider government debt to be a safe asset. Third, debt has safety and liquidity properties. The question is not only whether assets/liabilities provide sufficient safety but also whether they serve as means of payment in the same way that base money and deposits do. The key question then is: Do we need inside money? I don’t think that macroeconomics has a convincing answer to this question at this point. But I note that some preeminent macroeconomists (NK) argue that banks can create means of payment better than some governments. If this is true then John’s first argument partly misses the point (although he addresses a related point later).
In spite of these reservations, I share John’s view that in the aggregate, safety cannot be created by means of financial intermediation. Projects and claims to future tax revenue generate returns. The financial system can slice and distribute these returns in different ways (creating safer claims by rendering other claims less safe) but it cannot create safety in the aggregate.
(2) Households and firms no longer need assets (i.e., liabilities of financial institutions) with a fixed nominal value in order to make payments.
I agree. As John writes:
In the past, the only way that a security could be “liquid” is if it promised a fixed payment. You couldn’t walk in to a drugstore in 1935, or 1965, and trade an S&P500 index share for a candy bar. Now you can. (And as soon as it is cleared by blockchain, it will be even faster and cheaper than credit cards.) There is no reason your debit card cannot be linked to an asset whose value floats over time.
(3) If society really needs more “safe” claims such claims can be created on banks rather than in banks. As John writes:
Let the banks issue 100% equity. Then, let most of that equity be held by a mutual fund, ETF, or bank holding company, and let those issue deposits, long term debt, and a small amount of additional equity. Now I have “transformed” risky assets into riskfree debt via leverage. But the leverage is outside the bank.
I agree. In an article (2013) I have described a proposal by BIS economists that relies on equity financed banks and levered bank holding companies to help solve the too-big-to-fail problem.
(4) Why should less “safe” bank liabilities lead to a credit crunch?
I share John’s puzzlement with the often heard claim that fewer bank deposits would go hand in hand with less credit. I believe that this claim mostly reflects confusion about the interplay between national saving and investment on the one hand, and bank balance sheets on the other. There is no mechanical link between the two but of course, there are many indirect links.
All in all, I am as skeptical as John about the view that bank created money obviously is important. I think that bank created money has some useful roles to play but they are more subtle. At the same time, I believe that bank created money is likely to stay with us even if it is not socially useful. Proposals to ban inside money therefore are unlikely to succeed (see my writing on Vollgeld).
More from the recent working paper by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan Taylor (“The Rate of Return on Everything, 1870–2015“). (Previous blog post about the return on residential real estate.)
- Return data for 16 advanced economies over nearly 150 years …
- …on the income and capital gains (and thus, total returns) from equities, residential housing, government bonds, and government bills.
- Real returns average 7% p.a. for equity, 8% for housing, 2.5% for bonds, and 1% for bills.
- Housing returns are much less volatile than equity returns.
- Real interest rates have been volatile over the long-run, sometimes more so than real risky returns. Real interest rates peaked around 1880, 1930, and 1990. Current low real interest rates are “normal.”
- Risk premia have been volatile, but at lower than business cycle frequencies.
- r − g is rather stable in the long run and always positive. The difference rose during the end of the 19th and 20th century.
On Alphaville, Matthew Klein discusses recent work by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan Taylor (“The Rate of Return on Everything, 1870–2015“) according to which
Residential real estate, not equity, has been the best long-run investment over the course of modern history.
… but they didn’t calculate the returns most homeowners actually experience. Most people borrow to buy housing and most people live in their properties without renting them out. This makes a big difference.
… Net rental income has historically accounted for half of the total returns from owning housing. It’s also far less volatile, dramatically boosting the Sharpe ratio compared to what you would get just by looking at changes in house prices.
Housing has beaten stocks since 1950 because rental income has been better than dividend income, not because house prices have grown more than stock prices.
In BPEA, Natasha Sarin and Larry Summers argue that bank stock has not:
… we find that financial market information provides little support for the view that major institutions are significantly safer than they were before the crisis and some support for the notion that risks have actually increased. …
… financial markets may have underestimated risk prior to the crisis … Yet we believe that the main reason for our findings is that regulatory measures that have increased safety have been offset by a dramatic decline in the franchise value of major financial institutions, caused at least in part by these new regulations.
This table is taken from their paper:
However, their finding need not be as bad as it sounds. After all, bank regulators intended to insulate taxpayers against bank failure and to render the financial system more shock proof, not bank equity.
On VoxEU, Torben Andersen and Jonas Maibom point out that empirical findings of a positive correlation between efficiency and equity need not contradict elementary theoretical predictions.
The trade-off [between efficiency and equity] applies at the frontier of the possibility set of combinations of economic performance and income equality available to policy makers. If policies and institutions are ‘well-designed’, the country is at the frontier. There is no free lunch and a trade-off inevitably arises.
However, there may be many historical, institutional and political reasons why countries are not at the frontier. … in which case there is scope for improvements in both economic performance and income equality.
This insight leaves one important message. In cross-country comparisons … differences in the distance to the frontier should be accounted for …
In his blog, John Cochrane points to SoFi, a FinTech company, as proof that banking services can be delivered by institutions without the traditional characteristics of a bank.
SoFi finances loans by selling equity. The loans are securitized and the cash is reinvested in loans. As John points out:
- A “bank” (in the economic, not legal sense) can finance loans, raising money essentially all from equity and no conventional debt. And it can offer competitive borrowing rates — the supposedly too-high “cost of equity” is illusory.
- There is no necessary link between the business of taking and servicing deposits and that of making loans. Banks need not (try to) “transform” maturity or risk.
- To the extent that the bank wants to boost up the risk and return of its equity, it can do so by securitizing loans rather than by borrowing. (Securitized loans are not leverage — there is no promise of your money back when you want it. Investors bear any losses immediately and without recourse.)
- Equity-financed banking can emerge without new regulations, or a big new Policy Initiative. It’s enough to have relief from old regulations (“FDIC-free”).
- Since it makes no fixed-value promises, this structure is essentially run free and can’t cause or contribute to a financial crisis.
In jusletter.ch, Corinne Zellweger-Gutknecht argues that the legal status of central bank reserves is more equity- than debt-like—at least as far as the Swiss National Bank (SNB) is concerned. According to Zellweger-Gutknecht, reserves constitute debt only if the SNB is legally obliged to redeem them in exchange for central bank assets.
If the SNB purchases dollars against Swiss Francs in an open market operation, it creates reserves which are equity-like. But if it acquires dollars against Swiss Francs and is committed to engage in a reverse transaction in the future (a swap), then it (temporarily) creates reserves which are debt-like.
The Economist reports about a proposal by Jeremy Bulow and Paul Klemperer for equity recourse notes (ERNs) that could bolster a bank’s equity after negative shocks. While contingent convertible bonds (CoCos) are converted into equity when bank capital falls below a defined threshold, ERNs would convert when the share price fell below a trigger price. Moreover, the new shares would be valued at the trigger price even if the share price had fallen much lower. Low share prices thus would trigger both a conversion and a partial default.