By Steven K. Beckner
(MNI) – While, in hindsight, some of the data available to the
Federal Reserve and other authorities gave notice of the financial
crisis, more data and a different approach to analyzing them are needed
if a reliable “early warning system” for future crises is to be
developed, according to research by Federal Reserve Vice Chairman Donald
Kohn and others released Monday.
In a constantly changing financial market, financial supervisors
must look at the available data less like physicists and more like
intelligence analysts, Kohn and his co-authors contend.
The paper, written with Fed Board economists Matthew Eichner and
Michael Palumbo, is titled “Financial Statistics for the United States
and the Crisis: What Did They Get Right, What Did They Miss, and How
Should They Change?”
“Understandably, in the wake of the crisis, financial supervisors
and policymakers want to obtain better and earlier indications regarding
these critical, and apparently recurring, core vulnerabilities in the
financial system,” Kohn and company write.
They concede that there were “gaps” in the data and data analysis
leading up to the crisis and that “more comprehensive real-time data is
necessary.”
“But we also emphasize that collecting more data is only part of
the process of developing early warning systems,” Kohn and the Fed
staffers say. “More fundamental, in our view, is the need to use data in
a different way — in a way that integrates the ongoing analysis of
macro data to identify areas of interest with the development of highly
specialized information to illuminate those areas, including the
relevant instruments and transactional forms.”
Financial reform legislation making its way through Congress would
designate the Fed as a systemic risk regulator, but even before
enactment the Fed has decided to take a more “macroprudential” approach
to financial supervision — looking at an array of data to identify
developing imbalances and risks.
However, Kohn et al cautioned against being overly specific in
deciding in advance which data policymakers should focus on, because
they might end up “look(ing) for vulnerabilities in the wrong place,
particularly if the actual act of looking by macro- or microprudential
supervisors causes the locus of activity to shift into a new shadow
somewhere else.”
The paper contends that “gauging vulnerabilities in the financial
system requires targeted analysis by specialized research teams with
expertise and data tailored to particular areas (such as specific
financial instruments and transaction types) that might be identified by
unusual trends observed in aggregate statistics.”
However, the authors add, “we harbor no illusions about the
difficulty of collecting all the ‘right’ data in a timely fashion,
particularly because the dynamic nature of our financial system implies
that the relevant set of data is a moving target.”
Not only does it take time to design and implement a major data
collection project, but “standard approaches to aggregate data
collection and analysis may simply not be consistent with the dynamism
of the financial system, particularly in light of the tendency of
innovation to continually shift to outside of the areas to which
analysis and scrutiny are most directed.”
Kohn and his colleagues write that “gaps in data and analysis, in a
sense, defined the shadows in which this system grew and prevented the
building vulnerabilities from being recognized.”
But they add that, “while very important, collecting more data is
only part of the process of developing early warning systems. More
fundamental, in our view, is the need to use data in a different way –
in a way that can deliver more flexibility in targeting than static data
collection can allow.”
Various government statistics “sent signals” prior to the crisis,
they say, but making use of that data “required a tactical approach that
not only used the aggregate data as signals of where to look, but
expanded to include granular and specialized information that may have
been collected for purposes other than financial stability analysis or
even microprudential supervision.”
They liken aggregate data to “grainy images captured by
reconnaissance satellites: Images that are suggestive, but not
dispositive.”
“Improved data collections can provide the greatest value by
highlighting changes and inconsistencies that bear further investigation
using other, more-focused tools mobilized to deal with a particular
anomaly.”
Kohn and company give examples of how the data retrospectively
provided some advance warning but at the same time were inadequate.
Although Systems of National Account (SNA) data showed the buildup
in household leverage and indebtedness before the crisis, the paper
says, “the aggregate nature of data in the national financial and real
statistical accounts left them unsuited for illuminating the extent of
vulnerability that had evolved in the U.S. financial system.”
“In particular, data in the national accounts did not illuminate
substantial increases in the underlying riskiness of mortgage loans in
the years leading up to the financial crisis, nor did they convey the
extent to which maturity transformation was being undertaken by the
shadow financial system.”
And they write: “It is noteworthy that even as the debt service
ratio — and its mortgage debt component — surged to indicate greater
household leverage in the years leading to the financial crisis and
recession, measures of balance sheet leverage did not signal imminent
problem — in fact, even during the years of rapid household borrowing,
typical indicators of balance sheet leverage did not rise much at all,
on net.”
In other cases, Kohn et al say, the available data failed to
provide any clues to the approaching crisis, they say.
“Although financial statistics for the U.S. economy conveyed some
important information about rising household leverage more or less in
real time, their aggregate nature masked the buildup of important
underlying risk factors and did not convey the overall vulnerability of
the financial system to a reversal of the flows that had supported
economic activity and promoted liquidity and financial risk-taking
during the credit expansion,” they write.
Not conveyed, for instance, was “a material increase in the
underlying credit risk associated with the rapid growth of home
mortgages and a consequent increase in the vulnerability of borrowers to
a downturn in home prices or incomes,” they say.
Nor did data convey “the growth of maturity transformation outside
the traditional banking sector (where a significant proportion of the
funding comes from insured deposits held at institutions having explicit
access to external liquidity support) — that is, a greater reliance on
short-term funding for longer-term financial instruments — that left
the financial system highly vulnerable to a withdrawal of liquidity.”
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