Role of Computer in Daily Life

Financial Crises and Bank Liquidity Creation Allen N. Berger †  and Christa H. S. Bouwman †¡ October 2008 Financial crises and bank liquidity creation are often connected. We examine this connection from two perspectives. First, we examine the aggregate liquidity creation of banks before, during, and after five major financial crises in the U. S. from 1984:Q1 to 2008:Q1. We uncover numerous interesting patterns, such as a significant build-up or drop-off of â€Å"abnormal† liquidity creation before each crisis, where â€Å"abnormal† is defined relative to a time trend and seasonal factors.Banking and market-related crises differ in that banking crises were preceded by abnormal positive liquidity creation, while market-related crises were generally preceded by abnormal negative liquidity creation. Bank liquidity creation has both decreased and increased during crises, likely both exacerbating and ameliorating the effects of crises. Off-balance sheet guarantees such as loan commitments moved more than on-balance sheet assets such as mortgages and business lending during banking crises.Second, we examine the effect of pre-crisis bank capital ratios on the competitive positions and profitability of individual banks during and after each crisis. The evidence suggests that high capital served large banks well around banking crises – they improved their liquidity creation market share and profitability during these crises and were able to hold on to their improved performance afterwards. In addition, high-capital listed banks enjoyed significantly higher abnormal stock returns than low-capital listed banks during banking crises.These benefits did not hold or held to a lesser degree around marketrelated crises and in normal times. In contrast, high capital ratios appear to have helped small banks improve their liquidity creation market share during banking crises, market-related crises, and normal times alike, and the gains in market shar e were sustained afterwards. Their profitability improved during two crises and subsequent to virtually every crisis. Similar results were observed during normal times for small banks. †  University of South Carolina, Wharton Financial Institutions Center, and CentER – Tilburg University.Contact details: Moore School of Business, University of South Carolina, 1705 College Street, Columbia, SC 29208. Tel: 803-576-8440. Fax: 803-777-6876. E-mail: [email  protected] sc. edu. †¡ Case Western Reserve University, and Wharton Financial Institutions Center. Contact details: Weatherhead School of Management, Case Western Reserve University, 10900 Euclid Avenue, 362 PBL, Cleveland, OH 44106. Tel. : 216-368-3688. Fax: 216-368-6249. E-mail: christa. [email  protected] edu. Keywords: Financial Crises, Liquidity Creation, and Banking. JEL Classification: G28, and G21.The authors thank Asani Sarkar, Bob DeYoung, Peter Ritchken, Greg Udell, and participants at presentations at the Summer Research Conference 2008 in Finance at the ISB in Hyderabad, the International Monetary Fund, the University of Kansas’ Southwind Finance Conference, and Erasmus University for useful comments. Financial Crises and Bank Liquidity Creation 1. Introduction Over the past quarter century, the U. S. has experienced a number of financial crises. At the heart of these crises are often issues surrounding liquidity provision by the banking sector and financial markets (e. . , Acharya, Shin, and Yorulmazer 2007). For example, in the current subprime lending crisis, liquidity seems to have dried up as banks seem less willing to lend to individuals, firms, other banks, and capital market participants, and loan securitization appears to be significantly depressed. This behavior of banks is summarized by the Economist: â€Å"Although bankers are always stingier in a downturn, [†¦] lots of banks said they had also cut back lending because of a slide in their current or expe cted capital and liquidity. 1 The practical importance of liquidity during crises is buttressed by financial intermediation theory, which indicates that the creation of liquidity is an important reason why banks exist. 2 Early contributions argue that banks create liquidity by financing relatively illiquid assets such as business loans with relatively liquid liabilities such as transactions deposits (e. g. , Bryant 1980, Diamond and Dybvig 1983). More recent contributions suggest that banks also create liquidity off the balance sheet through loan commitments and similar claims to liquid funds (e. g. Holmstrom and Tirole 1998, Kashyap, Rajan, and Stein 2002). 3 The creation of liquidity makes banks fragile and susceptible to runs (e. g. , Diamond and Dybvig 1983, Chari and Jagannathan 1988), and such runs can lead to crises via contagion effects. Bank liquidity creation can also have real effects, in particular if a financial crisis ruptures the creation of liquidity (e. g. , Dellâ⠂¬â„¢Ariccia, Detragiache, and Rajan 2008). 4 Exploring the relationship between financial crises and bank liquidity creation can thus yield potentially interesting economic insights and may have important policy implications.The goals of this paper are twofold. The first is to examine the aggregate liquidity creation of 1 â€Å"The credit crisis: Financial engine failure† – The Economist, February 7, 2008. According to the theory, another central role of banks in the economy is to transform credit risk (e. g. , Diamond 1984, Ramakrishnan and Thakor 1984, Boyd and Prescott 1986). Recently, Coval and Thakor (2005) theorize that banks may also arise in response to the behavior of irrational agents in financial markets. 3James (1981) and Boot, Thakor, and Udell (1991) endogenize the loan commitment contract due to informational frictions. The loan commitment contract is subsequently used in Holmstrom and Tirole (1998) and Kashyap, Rajan, and Stein (2002) to show how banks can provide liquidity to borrowers. 4 Acharya and Pedersen (2005) show that liquidity risk also affects the expected returns on stocks. 2 1 banks around five financial crises in the U. S. over the past quarter century. 5 The crises include two banking crises (the credit crunch of the early 1990s and the subprime lending crisis of 2007 – ? and three crises that can be viewed as primarily market-related (the 1987 stock market crash, the Russian debt crisis plus the Long-Term Capital Management meltdown in 1998, and the bursting of the dot. com bubble plus the September 11 terrorist attack of the early 2000s). This examination is intended to shed light on whether there are any connections between financial crises and aggregate liquidity creation, and whether these vary based on the nature of the crisis (i. e. , banking versus market-related crisis). A good nderstanding of the behavior of bank liquidity creation around financial crises is also important to shed light on whether banks create â€Å"too little† or â€Å"too much† liquidity, and whether bank behavior exacerbates or ameliorates the effects of crises. We document the empirical regularities related to these issues, so as to raise additional interesting questions for further empirical and theoretical examinations. The second goal is to study the effect of pre-crisis equity capital ratios on the competitive positions and profitability of individual banks around each crisis.Since bank capital affects liquidity creation (e. g. , Diamond and Rajan 2000, 2001, Berger and Bouwman forthcoming), it is likely that banks with different capital ratios behave differently during crises in terms of their liquidity creation responses. Specifically, we ask: are high-capital banks able to gain market share in terms of liquidity creation at the expense of low-capital banks during a crisis, and does such enhanced market share translate into higher profitability? If so, are the high-capital banks able t o sustain their improved competitive positions after the financial crisis is over?The recent acquisitions of Countrywide, Bear Stearns, and Washington Mutual provide interesting case studies in this regard. All three firms ran low on capital and had to be bailed out by banks with stronger capital positions. Bank of America (Countrywide’s acquirer) and J. P. Morgan Chase (acquirer of Bear-Stearns and Washington Mutual’s banking operations) had capital ratios high enough to enable them to buy their rivals at a small fraction of what they were worth a year before, thereby gaining a potential competitive advantage. 6 The recent experience of IndyMac Bank provides 5Studies on the behavior of banks around financial crises have typically focused on commercial and real estate lending (e. g. , Berger and Udell 1994, Hancock, Laing, and Wilcox 1995, Dell’Ariccia, Igan, and Laeven 2008). We focus on the more comprehensive notion of bank liquidity creation. 6 On Sunday, Mar ch 16, 2008, J. P. Morgan Chase agreed to pay $2 a share to buy all of Bear Stearns, less than onetenth of the firm’s share price on Friday and a small fraction of the $170 share price a year before. On March 24, 2008, it increased its bid to $10, and completed the transaction on May 30, 2008.On January 11, Bank of America announced it would pay $4 billion for Countrywide, after Countrywide’s market capitalization had plummeted 85% during the preceding 12 months. The transaction was completed on July 1, 2008. After a $16. 4 billion ten-day bank 2 another interesting example. The FDIC seized IndyMac Bank after it suffered substantive losses and depositors had started to run on the bank. The FDIC intends to sell the bank, preferably as a single entity but if that does not work, the bank will be sold off in pieces.Given the way the regulatory approval process for bank acquisitions works, it is likely that the acquirer(s) will have a strong capital base. 7 A financial cris is is a natural event to examine how capital affects the competitive positions of banks. During â€Å"normal† times, capital has many effects on the bank, some of which counteract each other, making it difficult to learn much. For example, capital helps the bank cope more effectively with risk,8 but it also reduces the value of the deposit insurance put option (Merton 1977). During a crisis, risks become elevated and the risk-absorption capacity of capital becomes paramount.Banks with high capital, which are better buffered against the shocks of the crisis, may thus gain a potential advantage. To examine the behavior of bank liquidity creation around financial crises, we calculate the amount of liquidity created by the banking sector using Berger and Bouwman’s (forthcoming) preferred liquidity creation measure. This measure takes into account the fact that banks create liquidity both on and off the balance sheet and is constructed using a three-step procedure. In the f irst step, all bank assets, liabilities, equity, and off-balance sheet activities are classified as liquid, semi-liquid, or illiquid.This is done based on the ease, cost, and time for customers to obtain liquid funds from the bank, and the ease, cost, and time for banks to dispose of their obligations in order to meet these liquidity demands. This classification process uses information on both product category and maturity for all activities other than loans; due to data limitations, loans are classified based solely on category (â€Å"cat†). Thus, residential mortgages are classified as more liquid than business loans regardless of maturity because it is generally easier to securitize and sell such mortgages than business loans.In the second step, weights are assigned to these activities. The weights are consistent with the theory in that maximum liquidity is created when illiquid assets (e. g. , business loans) are transformed into liquid liabilities (e. g. , transactions deposits) and maximum liquidity is destroyed when liquid assets (e. g. , treasuries) are transformed into illiquid liabilities â€Å"walk†, Washington Mutual was placed into the receivership of the FDIC on September 25, 2008. J. P. Morgan Chase purchased the banking business for $1. 9 billion and re-opened the bank the next day.On September 26, 2008, the holding company and its remaining subsidiary filed for bankruptcy. Washington Mutual, the sixth-largest bank in the U. S. before its collapse, is the largest bank failure in the U. S. financial history. 7 After peaking at $50. 11 on May 8, 2006, IndyMac’s shares lost 87% of their value in 2007 and another 95% in 2008. Its share price closed at $0. 28 on July 11, 2008, the day before it was seized by the FDIC. 8 There are numerous papers that argue that capital enhances the risk-absorption capacity of banks (e. g. , Bhattacharya and Thakor 1993, Repullo 2004, Von Thadden 2004). (e. g. , subordinated debt) or equity. In the third step, a â€Å"cat fat† liquidity creation measure is constructed, where â€Å"fat† refers to the inclusion of off-balance sheet activities. Although Berger and Bouwman construct four different liquidity creation measures, they indicate that â€Å"cat fat† is the preferred measure. They argue that to assess the amount of liquidity creation, the ability to securitize or sell a particular loan category is more important than the maturity of those loans, and the inclusion of off-balance sheet activities is critical. We apply the â€Å"cat fat† liquidity creation measure to quarterly data on virtually all U. S. commercial and credit card banks from 1984:Q1 to 2008:Q1. Our measurement of aggregate liquidity creation by banks allows us to examine the behavior of liquidity created prior to, during, and after each crisis. The popular press has provided anecdotal accounts of liquidity drying up during some financial crises as well as excessive liquidity p rovision at other times that led to credit expansion bubbles (e. g. , the subprime lending crisis).We attempt to give empirical content to these notions of â€Å"too little† and â€Å"too much† liquidity created by banks. Liquidity creation has quadrupled in real terms over the sample period and appears to have seasonal components (as documented below). Since no theories exist that explain the intertemporal behavior of liquidity creation, we take an essentially empirical approach to the problem and focus on how far liquidity creation lies above or below a time trend and seasonal factors. 10 That is, we focus on â€Å"abnormal† liquidity creation.The use of this measure rests on the supposition that some â€Å"normal† amount of liquidity creation exists, acknowledging that at any point in time, liquidity creation may be â€Å"too much† or â€Å"too little† in dollar terms. Our main results regarding the behavior of liquidity creation around f inancial crises are as follows. First, prior to financial crises, there seems to have been a significant build-up or drop-off of â€Å"abnormal† liquidity creation. Second, banking and market-related crises differ in two respects.The banking crises (the credit crunch of 1990-1992 and the current subprime lending crisis) were preceded by abnormal positive liquidity creation by banks, whereas the market-related crises were generally preceded by abnormal negative liquidity creation. In addition, the banking crises themselves seemed to change the trajectory of aggregate liquidity creation, while the market-related crises did not appear to do so. Third, 9 Their alternative measures include â€Å"cat nonfat,† â€Å"mat fat,† and â€Å"mat nonfat. † The â€Å"nonfat† measures exclude offbalance sheet activities, and the â€Å"mat† measures classify loans by maturity rather than by product category. 0 As alternative approaches, we use the dollar amo unt of liquidity creation per capita and liquidity creation divided by GDP and obtain similar results (see Section 4. 2). 4 liquidity creation has both decreased during crises (e. g. , the 1990-1992 credit crunch) and increased during crises (e. g. , the 1998 Russian debt crisis / LTCM bailout). Thus, liquidity creation likely both exacerbated and ameliorated the effects of crises. Fourth, off-balance sheet illiquid guarantees (primarily loan commitments) moved more than semi-liquid assets (primarily mortgages) and illiquid assets (primarily business loans) during banking crises.Fifth, the current subprime lending crisis was preceded by an unusually high positive abnormal amount of aggregate liquidity creation, possibly caused by lax lending standards that led banks to extend increasing amounts of credit and off-balance sheet guarantees. This suggests a possible dark side of bank liquidity creation. While financial fragility may be needed to induce banks to create liquidity (e. g. , Diamond and Rajan 2000, 2001), our analysis raises the intriguing possibility that the causality may also be reversed in the sense that too much liquidity creation may lead to financial fragility.We then turn to the second goal of the paper – examining whether banks’ pre-crisis capital ratios affect their competitive positions and profitability around financial crises. To examine the effect on a bank’s competitive position, we regress the change in its market share of liquidity creation – measured as the average market share of aggregate liquidity creation during the crisis (or over the eight quarters after the crisis) minus the average market share over the eight quarters before the crisis, expressed as a proportion of the bank’s average pre-crisis market share – on its average pre-crisis capital ratio and a set of control variables. 1 Since the analyses in the first half of the paper reveal a great deal of heterogeneity in crises, we run these regressions on a per-crisis basis, rather than pooling the data across crises. The control variables include bank size, bank risk, bank holding company membership, local market competition,12 and proxies for the economic circumstances in the local markets in which the bank operates. Moreover, we examine large and small banks as two separate groups since the results in Berger and Bouwman (forthcoming) indicate that the effect of capital on liquidity creation differs across large and small banks. 13 11Defining market share this way is a departure from previous research (e. g. , Laeven and Levine 2007), in which market share relates to the bank’s weighted-average local market share of total deposits. 12 While our focus is on the change in banks’ competitive positions measured in terms of their aggregate liquidity creation market shares, we control for â€Å"local market competition† measured as the bank-level Herfindahl index based on local market deposit mar ket shares. 13 Berger and Bouwman use three size categories: large, medium, and small banks. We combine the large and medium bank categories into one â€Å"large bank† category. 5One potential concern is that differences in bank capital ratios may simply reflect differences in bank risk. Banks that hold higher capital ratios because their investment portfolios are riskier may not improve their competitive positions around financial crises. Our empirical design takes this into account. The inclusion of bank risk as a control variable is critical and ensures that the measured effect of capital on a bank’s market share is net of the effect of risk. We find evidence that high-capital large banks improved their market share of liquidity creation during the two banking crises, but not during the market-related crises.After the credit crunch of the early 1990s, high-capital large banks held on to their improved competitive positions. Since the current subprime lending crisis was not over at the end of the sample period, we cannot yet tell whether highcapital large banks will also hold on to their improved competitive positions after this crisis. In contrast to the large banks, high-capital small banks seemed to enhance their competitive positions during all crises and held on to their improved competitive positions after the crises as well.Next, we focus on the effect of pre-crisis bank capital on the profitability of the bank around each crisis. We run regressions that are similar to the ones described above with the change in return on equity (ROE) as the dependent variable. We find that high-capital large banks improved their ROE in those cases in which they enhanced their liquidity creation market share – the two banking crises – and were able to hold on to their improved profitability after the credit crunch. profitability after the market-related crises. They also increased theirIn contrast, for high-capital small banks, profitabilit y improved during two crises, and subsequent to virtually every crisis. As an additional analysis, we examine whether the improved competitive positions and profitability of high-capital banks translated into better stock return performance. To perform this analysis, we focus on listed banks and bank holding companies (BHCs). If multiple banks are part of the same listed BHC, their financial statements are added together to create pro-forma financial statements of the BHC.The results confirm the earlier change in performance findings of large banks: listed banks with high capital ratios enjoyed significantly larger abnormal returns than banks with low capital ratios during banking crises, but not during market-related crises. Our results are based on a five-factor asset pricing model that includes the three Fama-French (1993) factors, momentum, and a proxy for the slope of the yield curve. 6 We also check whether high capital provided similar advantages outside crisis periods, i. e. , during â€Å"normal† times.We find that large banks with high capital ratios did not enjoy either market share or profitability gains over the other large banks, whereas for small banks, results are similar to the smallbank findings discussed above. Moreover, outside banking crises, high capital was not associated with high stock returns. Combined, the results suggest that high capital ratios serve large banks well, particularly around banking crises. In contrast, high capital ratios appear to help small banks around banking crises, marketrelated crises, and normal times alike. The remainder of this paper is organized as follows.Section 2 discusses the related literature. Section 3 explains the liquidity creation measures and our sample based on data of U. S. banks from 1984:Q1 to 2008:Q1. Section 4 describes the behavior of aggregate bank liquidity creation around five financial crises and draws some general conclusions. Section 5 discusses the tests of the effects of pre crisis capital ratios on banks’ competitive positions and profitability around financial crises and â€Å"normal† times. This section also examines the stock returns of high- and low-capital listed banking organizations during each crisis and during normal† times. Section 6 concludes. 2. Related literature This paper is related to two literatures. The first is the literature on financial crises. 14 One strand in this literature has focused on financial crises and fragility. Some papers have analyzed contagion. Contributions in this area suggest that a small liquidity shock in one area may have a contagious effect throughout the economy (e. g. , Allen and Gale 1998, 2000). Other papers have focused on the determinants of financial crises and the policy implications (e. g. Bordo, Eichengreen, Klingebiel, and Martinez-Peria 2001, Demirguc-Kunt, Detragiache, and Gupta 2006, Lorenzoni 2008, Claessens, Klingebiel, and Laeven forthcoming). A second strand examines the e ffect of financial crises on the real sector (e. g. , Friedman and Schwarz 1963, Bernanke 1983, Bernanke and Gertler 1989, Dell’Ariccia, Detragiache, and Rajan 2008, Shin forthcoming). These papers find that financial crises increase the cost of financing and reduce credit, which adversely affects corporate investment and may lead to reduced 14Allen and Gale (2007) provide a detailed overview of the causes and consequences of financial crises. 7 growth and recessions. That is, financial crises have independent real effects (see Dell’Ariccia, Detragiache, and Rajan 2008). In contrast to these papers, we examine how the amount of liquidity created by the banking sector behaved around financial crises in the U. S. , and explore systematic patterns in the data. The second literature to which this paper is related focuses on the strategic use of leverage in product-market competition for non-financial firms (e. g. , Brander and Lewis 1986, Campello 2006, Lyandres 2006).This literature suggests that financial leverage can affect competitive dynamics. While this literature has not focused on banks, we analyze the effects of crises on the competitive positioning and profitability of banks based on their pre-crisis capital ratios. Our hypothesis is that in the case of banks, the competitive implications of capital are likely to be most pronounced during a crisis when a bank’s capitalization has a major influence on its ability to survive the crisis, particularly in light of regulatory discretion in closing banks or otherwise resolving problem institutions.Liquidity creation may be a channel through which this competitive advantage is gained or lost. 15 3. Description of the liquidity creation measure and sample We calculate the dollar amount of liquidity created by the banking sector using Berger and Bouwman’s (forthcoming) preferred â€Å"cat fat† liquidity creation measure. In this section, we explain briefly what this acronym stand s for and how we construct this measure. 16 We then describe our sample. All financial values are expressed in real 2007:Q4 dollars using the implicit GDP price deflator. 3. 1. Liquidity creation measureTo construct a measure of liquidity creation, we follow Berger and Bouwman’s three-step procedure (see Table 1). Below, we briefly discuss these three steps. In Step 1, we classify all bank activities (assets, liabilities, equity, and off-balance sheet activities) as liquid, semi-liquid, or illiquid. For assets, we do this based on the ease, cost, and time for banks to dispose of their obligations in order to meet these liquidity demands. For liabilities and equity, we do this 15 Allen and Gale (2004) analyze how competition affects financial stability. We reverse the causality and examine the effect of financial crises on competition. 6 For a more detailed discussion, see Berger and Bouwman (forthcoming). 8 based on the ease, cost, and time for customers to obtain liquid fund s from the bank. We follow a similar approach for off-balance sheet activities, classifying them based on functionally similar on-balance sheet activities. For all activities other than loans, this classification process uses information on both product category and maturity. Due to data restrictions, we classify loans entirely by category (â€Å"cat†). 17 In Step 2, we assign weights to all the bank activities classified in Step 1.The weights are consistent with liquidity creation theory, which argues that banks create liquidity on the balance sheet when they transform illiquid assets into liquid liabilities. We therefore apply positive weights to illiquid assets and liquid liabilities. Following similar logic, we apply negative weights to liquid assets and illiquid liabilities and equity, since banks destroy liquidity when they use illiquid liabilities to finance liquid assets. We use weights of ? and -? , because only half of the total amount of liquidity created is attrib utable to the source or use of funds alone.For example, when $1 of liquid liabilities is used to finance $1 in illiquid assets, liquidity creation equals ? * $1 + ? * $1 = $1. In this case, maximum liquidity is created. However, when $1 of liquid liabilities is used to finance $1 in liquid assets, liquidity creation equals ? * $1 + -? * $1 = $0. In this case, no liquidity is created as the bank holds items of approximately the same liquidity as those it gives to the nonbank public. Maximum liquidity is destroyed when $1 of illiquid liabilities or equity is used to finance $1 of liquid assets. In this case, liquidity creation equals -? $1 + -? * $1 = -$1. An intermediate weight of 0 is applied to semi-liquid assets and liabilities. Weights for off-balance sheet activities are assigned using the same principles. In Step 3, we combine the activities as classified in Step 1 and as weighted in Step 2 to construct Berger and Bouwman’s preferred â€Å"cat fat† liquidity creat ion measure. This measure classifies loans by category (â€Å"cat†), while all activities other than loans are classified using information on product category and maturity, and includes off-balance sheet activities (â€Å"fat†).Berger and Bouwman construct four liquidity creation measures by alternatively classifying loans by category or maturity, and by alternatively including or excluding off-balance sheet activities. However, they argue that â€Å"cat fat† is the preferred measure since for liquidity creation, banks’ ability to securitize or sell loans is more important than loan maturity, and banks do create liquidity both on the balance sheet and off the balance sheet. 17 Alternatively, we could classify loans by maturity (â€Å"mat†).However, Berger and Bouwman argue that it is preferable to classify them by category since for loans, the ability to securitize or sell is more important than their maturity. 9 To obtain the dollar amount of liq uidity creation at a particular bank, we multiply the weights of ? , -? , or 0, respectively, times the dollar amounts of the corresponding bank activities and add the weighted dollar amounts. 3. 2. Sample description We include virtually all commercial and credit card banks in the U. S. in our study. 18 For each bank, we obtain quarterly Call Report data from 1984:Q1 to 2008:Q1.We keep a bank if it: 1) has commercial real estate or commercial and industrial loans outstanding; 2) has deposits; 3) has an equity capital ratio of at least 1%; 4) has gross total assets or GTA (total assets plus allowance for loan and lease losses and the allocated transfer risk reserve) exceeding $25 million. We end up with data on 18,134 distinct banks, yielding 907,159 bank-quarter observations over our sample period. For each bank, we calculate the dollar amount of liquidity creation using the process described in Section 3. 1.The amount of liquidity creation and all other financial values are put in to real 2007:Q4 dollars using the implicit GDP price deflator. When we explore aggregate bank liquidity creation around financial crises, we focus on the real dollar amount of liquidity creation by the banking sector. To obtain this, we aggregate the liquidity created by all banks in each quarter and end up with a sample that contains 97 inflation-adjusted, quarterly liquidity creation amounts. In contrast, when we examine how capital affects the competitive positions of banks, we focus on the amount of liquidity created by individual banks around each crisis.Given documented differences between large and small banks in terms of portfolio composition (e. g. , Kashyap, Rajan, and Stein 2002, Berger, Miller, Petersen, Rajan, and Stein 2005) and the effect of capital on liquidity creation (Berger and Bouwman forthcoming), we split the sample into large banks (between 330 and 477 observations, depending on the crisis) and small banks (between 5556 and 6343 observations, depending on the crisis), and run all change in market share and profitability regressions separately for these two sets of banks.Large banks have gross total assets (GTA) exceeding $1 billion at the end of the quarter before a crisis 18 Berger and Bouwman (forthcoming) include only commercial banks. We also include credit card banks to avoid an artificial $0. 19 trillion drop in bank liquidity creation in the fourth quarter of 2006 when Citibank N. A. moved its credit-card lines to Citibank South Dakota N. A. , a credit card bank. 10 and small banks have GTA up to $1 billion at the end of that quarter. 19,20 4.The behavior of aggregate bank liquidity creation around financial crises This section focuses on the first goal of the paper – examining the aggregate liquidity creation of banks across five financial crises in the U. S. over the past quarter century. The crises include the 1987 stock market crash, the credit crunch of the early 1990s, the Russian debt crisis plus Long-Term Capital M anagement (LTCM) bailout of 1998, the bursting of the dot. com bubble and the Sept. 11 terrorist attacks of the early 2000s, and the current subprime lending crisis. We first provide summary statistics and explain our empirical approach.We then discuss alternative measures of abnormal liquidity creation. Next, we describe the behavior of bank liquidity creation before, during, and after each crisis. Finally, we draw some general conclusions from these results. 4. 1. Summary statistics and empirical approach Figure 1 Panel A shows the dollar amount of liquidity created by the banking sector, calculated using the â€Å"cat fat† liquidity creation measure over our sample period. As shown, liquidity creation has increased substantially over time: it has more than quadrupled from $1. 369 trillion in 1984:Q1 to $5. 06 trillion in 2008:Q1 (in real 2007:Q4 dollars). We want to examine whether liquidity creation by the banking sector is â€Å"high,† â€Å"low,† or at a à ¢â‚¬Å"normal† level around financial crises. Since no theories exist that explain the intertemporal behavior of liquidity creation or generate numerical estimates of â€Å"normal† liquidity creation, we need a reasonable empirical approach. At first blush, it may seem that we could simply calculate the average amount of bank liquidity creation over the entire sample period and view amounts above this sample average as â€Å"high† and amounts below the average as â€Å"low. However, Figure 1 Panel A clearly shows that this approach would cause us to classify the entire second half of the sample period (1996:Q1 – 2008:Q1) as â€Å"high† and the entire first half of the sample period (1984:Q1 – 1995:Q4) as â€Å"low. † We therefore do not 19 As noted before, we combine Berger and Bouwman’s large and medium bank categories into one â€Å"large bank† category. Recall that all financial values are expressed in real 2007:Q4 dol lars. 20 GTA equals total assets plus the allowance for loan and lease losses and the allocated transfer risk reserve.Total assets on Call Reports deduct these two reserves, which are held to cover potential credit losses. We add these reserves back to measure the full value of the loans financed and the liquidity created by the bank on the asset side. 11 use this approach. The approach we take is aimed at calculating the â€Å"abnormal† amount of liquidity created by the banking sector based on a time trend. It focuses on whether liquidity creation lies above or below this time trend, and also deseasonalizes the data to ensure that we do not base our conclusions on mere seasonal effects.We detrend and deseasonalize the data by regressing the dollar amount of liquidity creation on a time index and three quarterly dummies. The residuals from this regression measure the â€Å"abnormal† dollar amount of liquidity creation in a particular quarter. That is, they measure how far (deseasonalized) liquidity creation lies above or below the trend line. If abnormal liquidity creation is greater than (smaller than) $0, the dollar amount of liquidity created by the banking sector lies above (below) the time trend.If abnormal liquidity creation is high (low) relative to the time trend and seasonal factors, we will interpret this as liquidity creation being â€Å"too high† (â€Å"too low†). Figure 1 Panel B shows abnormal liquidity creation over time. The amount of liquidity created by the banking sector was high (yet declining) in the mid-1980s, low in the mid-1990s, and high (and mostly rising) in the most recent years. 4. 2. Alternative measures of abnormal liquidity creation We considered several alternative approaches to measuring abnormal liquidity creation. One possibility is to scale the dollar amount of liquidity creation by total population.The idea behind this approach is that a â€Å"normal† amount of liquidity creation may exi st in per capita terms. The average amount of liquidity creation per capita over our sample period could potentially serve as the â€Å"normal† amount and deviations from this average would be viewed as abnormal. To calculate per capita liquidity creation we obtain annual U. S. population estimates from the U. S. Census Bureau. Figure 2 Panel A shows per capita liquidity creation over time. The picture reveals that per capita liquidity creation more than tripled from $5. 8K in 1984:Q1 to $18. 8K in 2008:Q1.Interestingly, the picture looks very similar to the one shown in Panel A, perhaps because the annual U. S. population growth rate is low. For reasons similar to those in our earlier analysis, we calculate abnormal per capita liquidity creation by detrending and deseasonalizing the data like we did in the previous section. Figure 2 Panel B shows abnormal per capita liquidity creation over time. 12 Another possibility is to scale the dollar amount of liquidity creation by GD P. Since liquidity creation by banks may causally affect GDP, this approach seems less appropriate.Nonetheless, we show the results for completeness. Figure 2 Panel C shows the dollar amount of liquidity creation divided by GDP. The picture reveals that bank liquidity creation has increased from 19. 9% of GDP in 1984:Q1 to 40. 4% of GDP in 2008:Q1. While liquidity creation more than quadrupled over the sample period, GDP doubled. Importantly, the picture looks similar to the one shown in Panel A. Again, for reasons similar to those in our earlier analysis, we detrend and deseasonalize the data to obtain abnormal liquidity creation divided by GDP.Figure 2 Panel D shows abnormal liquidity creation divided by GDP over time. Since these alternative approaches yield results that are similar to those shown in Section 4. 1, we focus our discussions on the abnormal amount of liquidity creation (rather than the abnormal amount of per capita liquidity creation or the abnormal amount of liquid ity creation divided by GDP) around financial crises. 4. 3. Abnormal bank liquidity creation before, during, and after five financial crises We now examine how abnormal bank liquidity creation behaved efore, during, and after five financial crises. In all cases, the pre-crisis and post-crisis periods are defined to be eight quarters long. 21 The one exception is that we do not examine abnormal bank liquidity creation after the current subprime lending crisis, since this crisis was still ongoing at the end of the sample period. Figure 3 Panels A – E show the graphs of the abnormal amount of liquidity creation for the five crises. This subsection is a fact-finding effort and largely descriptive. In Section 4. , we will combine the evidence gathered here and interpret it to draw some general conclusions. Financial crisis #1: Stock market crash (1987:Q4) On Monday, October 19, 1987, the stock market crashed, with the S&P500 index falling about 20%. During the years before the cra sh, the level of the stock market had increased dramatically, causing some 21 As a result of our choice of two-year pre-crisis and post-crisis periods, the post-Russian debt crisis period overlaps with the bursting of the dot. com bubble, and the pre-dot. com bubble period overlaps with the Russian debt crisis.For these two crises, we redo our analyses using six-quarter pre-crisis and post-crisis periods and obtain results that are qualitatively similar to the ones documented here. 13 concern that the market had become overvalued. 22 A few days before the crash, two events occurred that may have helped precipitate the crash: 1) legislation was enacted to eliminate certain tax benefits associated with financing mergers; and 2) information was released that the trade deficit was above expectations. Both events seemed to have added to the selling pressure and a record trading volume on Oct. 9, in part caused by program trading, overwhelmed many systems. Figure 3 Panel A shows abnormal bank liquidity creation before, during, and after the stock market crash. Although this financial crisis seems to have originated in the stock market rather than the banking system, it is clear from the graph that abnormal liquidity creation by banks was high ($0. 5 trillion above the time trend) two years before the crisis. It had already dropped substantially before the crisis and continued to drop until well after the crisis, but was still above the time trend even a year after the crisis.Financial crisis #2: Credit crunch (1990:Q1 – 1992:Q4) During the first three years of the 1990s, bank commercial and industrial lending declined in real terms, particularly for small banks and for small loans (see Berger, Kashyap, and Scalise 1995, Table 8, for details). The ascribed causes of the credit crunch include a fall in bank capital from the loan loss experiences of the late 1980s (e. g. , Peek and Rosengren 1995), the increases in bank leverage requirements and implementation o f Basel I risk-based capital standards during this time period (e. g. Berger and Udell 1994, Hancock, Laing, and Wilcox 1995, Thakor 1996), an increase in supervisory toughness evidenced in worse examination ratings for a given bank condition (e. g. , Berger, Kyle, and Scalise 2001), and reduced loan demand because of macroeconomic and regional recessions (e. g. , Bernanke and Lown 1991). To some extent, the research supports virtually all of these hypotheses. Figure 3 Panel B shows how abnormal liquidity creation behaved before, during, and after the credit crunch. The graph shows that liquidity creation was above the time trend before the crisis, but declining.After a temporary increase, it dropped markedly during the crisis by roughly $0. 6 trillion, and the decline even extended a bit beyond the crunch period. After having reached a noticeably low level in the post-crunch period, liquidity creation slowly started to bottom out. This evidence suggests that the 22 E. g. , â€Å"R aging bull, stock market’s surge is puzzling investors: When will it end? † on page 1 of the Wall Street Journal, Jan. 19, 1987. 14 banking sector created (slightly) positive abnormal liquidity before the crisis, but created significantly negative abnormal liquidity during and fter the crisis, representing behavior by banks that may have further fueled the crisis. Financial crisis #3: Russian debt crisis / LTCM bailout (1998:Q3 – 1998:Q4) Since its inception in March 1994, hedge fund Long-Term Capital Management (â€Å"LTCM†) followed an arbitrage strategy that was avowedly â€Å"market neutral,† designed to make money regardless of whether prices were rising or falling. When Russia defaulted on its sovereign debt on August 17, 1998, investors fled from other government paper to the safe haven of U. S. treasuries.This flight to liquidity caused an unexpected widening of spreads on supposedly low-risk portfolios. By the end of August 1998, LTCMâ€⠄¢s capital had dropped to $2. 3 billion, less than 50% of its December 1997 value, with assets standing at $126 billion. In the first three weeks of September, LTCM’s capital dropped further to $600 million without shrinking the portfolio. Banks began to doubt its ability to meet margin calls. To prevent a potential systemic meltdown triggered by the collapse of the world’s largest hedge fund, the Federal Reserve Bank of New York organized a $3. billion bail-out by LTCM’s major creditors on September 23, 1998. In 1998:Q4, many large banks had to take substantial write-offs as a result of losses on their investments. Figure 3 Panel C shows abnormal liquidity creation around the Russian debt crisis and LTCM bailout. The pattern shown in the graph is very different from the ones we have seen so far. Liquidity creation was abnormally negative before the crisis, but increasing. Liquidity creation increased further during the crisis, countercyclical behavior by banks that may have alleviated the crisis, and continued to grow after the crisis.This suggests that liquidity creation may have been too low entering the crisis and returned to normal levels a few quarters after the end of the crisis. Financial crisis #4: Bursting of the dot. com bubble and Sept. 11 terrorist attack (2000:Q2 – 2002:Q3) The dot. com bubble was a speculative stock price bubble that was built up during the mid to late 1990s. During this period, many internet-based companies, commonly referred to as â€Å"dot. coms,† were founded. Rapidly increasing stock prices and widely available venture capital created an environment in which 15 any of these companies seemed to focus largely on increasing market share. At the height of the boom, it seemed possible for dot. com’s to go public and raise substantial amounts of money even if they had never earned any profits, and in some cases had not even earned any revenues. On March 10, 2000, the Nasdaq composite ind ex peaked at more than double its value just a year before. After the bursting of the bubble, many dot. com’s ran out of capital and were acquired or filed for bankruptcy (examples of the latter include WorldCom and Pets. com). The U. S. economy started to slow down and business nvestments began falling. The September 11, 2001 terrorist attacks may have exacerbated the stock market downturn by adversely affecting investor sentiment. By 2002:Q3, the Nasdaq index had fallen by 78%, wiping out $5 trillion in market value of mostly technology firms. Figure 3 Panel D shows how abnormal liquidity creation behaved before, during, and after the bursting of the dot. com bubble and the Sept. 11 terrorist attacks. The graph shows that before the crisis period, liquidity creation moved from displaying a negative abnormal value to displaying a positive abnormal value at the time the bubble burst.During the crisis, liquidity creation declined somewhat and hovered around the time trend by t he time the crisis was over. After the crisis, liquidity creation slowly started to pick up again. Financial crisis #5: Subprime lending crisis (2007:Q3 – ? ) The subprime lending crisis has been characterized by turmoil in financial markets as banks have experienced difficulty in selling loans in the syndicated loan market and in securitizing loans. Banks also seem to be reluctant to provide credit: they appear to have cut back their lending to firms and individuals, and have also been reticent to lend to each other.Risk premia have increased as evidenced by a higher premium over treasuries for mortgages and other bank products. Some banks have experienced massive losses in capital. For example, Citicorp had to raise about $40 billion in equity to cover subprime lending and other losses. Massive losses at Countrywide resulted in a takeover by Bank of America. Bear Stearns suffered a fatal loss in confidence and was sold at a fire-sale price to J. P. Morgan Chase with the Fed eral Reserve guaranteeing $29 billion in potential losses. Washington Mutual, the sixth-largest bank, became the biggest bank failure in the U.S. financial history. J. P. Morgan Chase purchased the banking business while the rest of the organization filed for bankruptcy. The Federal Reserve intervened in some 16 unprecedented ways in the market, extending its safety-net privileges to investment banks. In addition to lowering the discount rate sharply, it also began holding mortgage-backed securities and lending directly to investment banks. Subsequently, IndyMac Bank was seized by the FDIC after it suffered substantive losses and depositors had started to run on the bank. This failure is expected to cost the FDIC $4 billion – $8 billion.The FDIC intends to sell the bank. Congress also recently passed legislation to provide Freddie Mac and Fannie Mae with unlimited credit lines and possible equity injections to prop up these troubled organizations, which are considered too big to fail. Figure 3 Panel E shows abnormal liquidity creation before and during the first part of the subprime lending crisis. The graph suggests that liquidity creation displayed a high positive abnormal value that was increasing before the crisis hit, with abnormal liquidity creation around $0. 0 trillion entering the crisis, decreasing substantially after the crisis hit. A striking fact about this crisis compared to the other crises is the relatively high build-up of positive abnormal liquidity creation prior to the crisis. 4. 4. Behavior of some liquidity creation components around the two banking crises It is of particular interest to examine the behavior of some selected components of liquidity creation around the banking crises. As discussed above (Section 4. 3), numerous papers have focused on the credit crunch, examining lending behavior.These studies generally find that mortgage and business lending started to decline significantly during the crisis. Here we contrast the cr edit crunch experience with the current subprime lending crisis, and expand the components of liquidity creation that are examined. Rather than focusing on mortgages and business loans, we examine the two liquidity creation components that include these items – semi-liquid assets (primarily mortgages) and illiquid assets (primarily business loans). In addition, we analyze two other components of liquidity creation.We examine the behavior of liquid assets to address whether a decrease (increase) in semi-liquid assets and / or illiquid assets tended to be accompanied by an increase (decrease) in liquid assets. We also analyze the behavior of illiquid off-balance sheet guarantees (primarily loan commitments) to address whether illiquid assets and illiquid off-balance sheet guarantees move in tandem around banking crises and whether changes in one are more pronounced than the other. Figure 4 Panels A and B show the abnormal amount of four liquidity creation components around 17 h e credit crunch and the subprime lending crisis, respectively. For ease of comparison, the components are not weighted by weights of +? (illiquid assets and illiquid off-balance sheet guarantees), 0 (semiliquid assets), and –? (liquid assets). The abnormal amounts are obtained by detrending and deseasonalizing each liquidity creation component. Figure 4 Panel A shows that abnormal semi-liquid assets decreased slightly during the credit crunch, while abnormal illiquid assets and especially abnormal illiquid guarantees dropped significantly and turned negative.This picture suggests that these components fell increasingly below the trendline. The dramatic drop in abnormal illiquid assets and abnormal illiquid off-balance sheet guarantees (which carry positive weights) helps explain the significant decrease in abnormal liquidity creation during the credit crunch shown in Figure 3 Panel B. Figure 4 Panel B shows that these four components of abnormal liquidity creation were above the trendline before and during the subprime lending crisis.Illiquid assets and especially off-balance sheet guarantees move further and further above the trendline before the crisis, which helps explain the dramatic buildup in abnormal liquidity creation before the subprime lending crisis shown in Figure 3 Panel E. All four components of abnormal liquidity creation continued to increase at the beginning of the crisis. After the first quarter of the crisis, illiquid off-balance sheet guarantees showed a significant decrease, which helps explain the decrease in abnormal liquidity creation in Figure 3 Panel E.On the balance sheet, during the final quarter of the sample period (the third quarter of the crisis), abnormal semi-liquid and illiquid assets declined, while abnormal liquid assets increased. 4. 5. General conclusions from the results What do we learn from the various graphs in the previous analyses that indicate intertemporal patterns of liquidity creation and selected liquidi ty creation components around five financial crises? First, across all the financial crises, there seems to have been a significant build-up or drop-off of abnormal liquidity creation before the crisis.This is consistent with the notion that crises may be preceded by either â€Å"too much† or â€Å"too little† liquidity creation, although at this stage we offer this as tentative food for thought rather than as a conclusion. Second, there seem to be two main differences between banking crises and market-related crises. 18 The banking crises, namely the credit crunch and the subprime lending crisis, were both preceded by positive abnormal liquidity creation by banks, while two out of the three market-related crises were preceded by negative abnormal liquidity creation.In addition, during the two banking crises, the crises themselves seem to have exerted a noticeable influence on the pattern of aggregate liquidity creation by banks. Just prior to the credit crunch, abnorm al liquidity creation was positive and had started to trend upward, but reversed course and plunged quite substantially to become negative during and after the crisis. Just prior to the subprime lending crisis, aggregate liquidity creation was again abnormally positive and trending up, but began to decline during the crisis, although it remains abnormally high by historical standards.The other crises, which are less directly related to banks, did not seem to exhibit such noticeable impact. Third, liquidity creation has both decreased during crises (e. g. , the 1990-1992 credit crunch) and increased during crises (e. g. , the 1998 Russian debt crisis / LTCM bailout). Thus, liquidity creation likely both exacerbated and ameliorated the effects of crises. Fourth, off-balance sheet illiquid guarantees (primarily loan commitments) moved more than semi-liquid assets (primarily mortgages) and illiquid assets (primarily business loans) during banking crises.Fifth, while liquidity creation i s generally thought of as a financial intermediation service with positive economic value at the level of the individual bank and individual borrower (see Diamond and Rajan 2000, 2001), our analysis hints at the existence of a â€Å"dark side† to liquidity creation. Specifically, it may be more than coincidence that the subprime lending crisis was preceded by a very high level of positive abnormal aggregate liquidity creation by banks relative to historical levels.The notion that this may have contributed to the subprime lending crisis is consistent with the findings that banks adopted lax credit standards (see Dell’Ariccia, Igan, and Laeven 2008, Keys, Mukherjee, Seru, and Vig 2008), which in turn could have led to an increase in credit availability and off-balance sheet guarantees. Thus, while Diamond and Rajan (2000, 2001) argue that financial fragility is needed to create liquidity, our analysis offers the intriguing possibility that the causality may be reversed a s well: too much liquidity creation may lead to financial fragility. 9 5. The effect of capital on banks’ competitive positions and profitability around financial crises This section focuses on the second goal of the paper – examining how bank capital affects banks’ competitive positions and profitability around financial crises. We first explain our methodology and provide summary statistics. We then present and discuss the empirical results. In an additional check, we examine whether the stock return performance of high- and low-capital listed banks is consistent with the competitive position and profitability results for large banks.In another check, we generate some â€Å"fake† crises to analyze whether our findings hold during â€Å"normal† times as well. 5. 1. Empirical approach To examine whether banks with high capital ratios improve their competitive positions and profitability during financial crises, and if so, whether they are able to h old on to this improved performance after these crises, we focus on the behavior of individual banks rather than that of the banking sector as a whole.Because our analysis of aggregate liquidity creation by banks shows substantial differences across crises, we do not pool the data from all the crises but instead analyze each crisis separately. Our findings below that the coefficients of interest differ substantially across crises tend to justify this separate treatment of the different crises. We use the following regression specification for each of the five crises: ? PERFi,j = ? + ? 1 * EQRATi,j + B * Zi,j (1) where ?PERFi,j is the change in bank i’s performance around crisis j, EQRATi,j is the bank’s average capital ratio before the crisis, and Zi,j includes a set of control variables averaged over the pre-crisis period. All of these variables are discussed in Section 5. 2. Since we use a cross-sectional regression model, bank and year fixed effects are not included . In all regressions, t-statistics are based on robust standard errors. Given documented differences between large and small banks in terms of portfolio composition (e. g. Kashyap, Rajan, and Stein 2002, Berger, Miller, Petersen, Rajan, and Stein 2005) and the effect of capital on liquidity creation (Berger and Bouwman forthcoming), we split the sample into large and small banks, and run all regressions separately for these two sets of banks. Large banks have gross total assets (GTA) exceeding $1 billion at the end of the quarter preceding the crisis and small banks have GTA up to 20 $1 billion at the end of that quarter. 5. 2. Variable descriptions and summary statistics We use two measures of a bank’s performance: competitive position and profitability.The bank’s competitive position is measured as the bank’s market share of overall liquidity creation, i. e. , the dollar amount of liquidity created by the bank divided by the dollar amount of liquidity created by the industry. Our focus on the share of liquidity creation is a departure from the traditional focus on a bank’s market share of deposits. Liquidity creation is a more comprehensive measure of banking activities since it does not just consider one funding item but instead is based on all the bank’s on-balance sheet and off-balance sheet activities.To establish whether banks improve their competitive positions during the crisis, we define the change in liquidity creation market share, ? LCSHARE, as the bank’s average market share during the crisis minus its average market share over the eight quarters before the crisis, normalized by its average pre-crisis market share. To examine whether these banks hold on to their improved performance after the crisis, we also measure each bank’s average market share over the eight quarters after the crisis minus its average market share over the eight quarters before the crisis, again normalized by its average marke t share before the crisis.The second performance measure is the bank’s profitability, measured as the return on equity (ROE), i. e. , net income divided by stockholders equity. 23 To examine whether a bank improves its profitability during a crisis, we focus on the change in profitability, ? ROE, measured as the bank’s average ROE during the crisis minus the bank’s average ROE over the eight quarters before the crisis. 24 To analyze whether the bank is able to hold on to improved profitability, we focus on the bank’s average ROE over the eight quarters after the crisis minus its average ROE over the eight quarters before the crisis.To mitigate the influence of outliers, ? LCSHARE and ? ROE are winsorized at the 3% level. Furthermore, to ensure that average values are calculated based on a sufficient number of quarters, we 23 We use ROE, the bank’s net income divided by equity, rather than return on assets (ROA), net income divided by assets, since banks may have substantial off-balance sheet portfolios. Banks must allocate capital against every offbalance sheet activity they engage in. Hence, net income and equity both reflect the bank’s on-balance sheet and off-balance sheet activities.In contrast, ROA divides net income earned based on on-balance sheet and off-balance sheet activities merely by the size of the on-balance sheet activities. 24 We do not divide by the bank’s ROE before the crisis since ROE itself is already a scaled variable. 21 require that at least half of a bank’s pre-crisis / crisis / post-crisis observations are available for both performance measures around a crisis. Since the subprime lending crisis was still ongoing at the end of the sample period, we require that at least half of a bank’s pre-subprime crisis observations and all three quarters of its subprime crisis observations are available.The key exogenous variable is EQRAT, the bank’s capital ratio averaged over the eight quarters before the crisis. EQRAT is the ratio of equity capital to gross total assets, GTA. 25 The control variables include: bank size, bank risk, bank holding company membership, local market competition, and proxies for the economic environment. Bank size is controlled for by including lnGTA, the log of GTA, in all regressions. In addition, we run regressions separately for large and small banks. We include the z-score to control for bank risk. 26 The z-score indicates the bank’s distance from default (e. g. Boyd, Graham, and Hewitt 1993), with higher values indicating that a bank is less likely to default. It is measured as a bank’s return on assets plus the equity capital/GTA ratio divided by the standard deviation of the return on assets over the eight quarters before the crisis. To control for bank holding company status, we include D-BHC, a dummy variable that equals 1 if the bank was part of a bank holding company. Bank holding company membership m ay affect a bank’s competitive position because the holding company is required to act as a source of strength to all the banks it owns, and may also inject equity voluntarily when needed.In addition, other banks in the holding company provide cross-guarantees. Furthermore, Houston, James, and Marcus (1997) find that bank loan growth depends on BHC membership. We control for local market competition by including HERF, the bank-level HerfindahlHirschman index of deposit concentration for the markets in which the bank is p

Introduction to Economics Exercise 1

INTRODUCTION TO ECONOMICS Exercise 1 1. What determines that a resource be scarce? Why is scarcity important in defining Economics as a science Resources are seen as being scarce, when the wants exceed the resources. The fundamental problem of economics relates to the choices made in the face of limited resources and unlimited wants. 2. Read your local newspaper and economic magazines. Explain the difference between Microeconomics and Macroeconomics. From your research, give three examples of microeconomic and macroeconomic issues.Microeconomics relates to the study of households and firms and the interaction between these different economic actors. Macroeconomics, however, relates to the study of the economy as a whole, and in particular problems pertaining to growth, unemployment and inflation. Examples of microeconomic issues: 1. price ceilings/floors 2. positive/negative externalities 3. elasticity Examples of macroeconomic issues: 1. inflation 2. unemployment 3. economic growth (GDP) 3. Regarding the concept of Opportunity Cost, comment how your opportunity cost of going to the movies may be affected when: a.You have a final exam the following day b. The University will be shut down for a month starting today c. The same movie will be shown on TV tomorrow a) increase b) decrease c) increase 4. Explain if the following statements are true or false, Explain your reply d. The opportunity cost of choosing a certain activity is equal to the sum of all the benefits of all the alternatives not chosen. e. Opportunity cost is a subjective measure a) False – the opportunity cost of choosing a certain activity is equal to the cost of the next best alternative forgone. ) True – opportunity cost relates to the individual, in that they must choose how to maximize their own utility/happiness, and opportunity cost can vary from individual to individual. 5. Under what conditions is it possible to expand the Production Possibility Frontier (If it is not possib le, explain your reply) The PPF can expand during periods of technological innovation or the discovery of new resources. Or through the process of trade. 6. a) England 2/6 = 1/3, USA 1/5 b) Wheat = England, Clothes = England c) England = Wheat, USA = Clothes ) England should produce wheat and USA clothes. Using the following table Hours of work needed to produce one unit | England| USA| Wheat| 2| 1| Clothes| 6| 5| | | | a. What is the opportunity cost of producing wheat in England and in the USA b. Which country has an absolute advantage in the production of wheat, and of clothes c. Which country has a comparative advantage in producing wheat and producing clothes d. Which country should specialize in the production of wheat? And of clothes? a. GRAPH b. GRAPH c. GRAPHThe Price is above market equilibrium: If the price exceeds the equilibrium price, a surplus occurs and there will be competition among the sellers and price will come down to the equilibrium point. This way the equilib rium is tried to maintain in each of the cases. d. GRAPH Price is below the market equilibrium: If the price is below the equilibrium a shortage occurs and there will be a competition among the buyers and the price will rise to the equilibrium level. This is also another way to restore the equilibrium though there are changes that are occurring in the market in the prices. . The inferior good demand will decrease when consumer income rises. These goods are affordable and adequately fulfill their purpose, but as more costly substitutes that offer more pleasure become available, the use of the inferior goods diminishes. f. A  complementary good  is a  good  with a negative  cross elasticity of demand. This means the demand for a good will decrease when the price of the complementary good is increased. g. If there is a rumor that price for this good will increase, demand will probably increase too. Consumers want to purchase the product before any increase.All the market will be affect; we will see an increase of demand for main and complementary goods. Shortage will probably appear and price will increase to search equilibrium. Rumor will be reality. 7. Using the following demand and supply table Price| Demand| Supply| 1. 25| 8| 28| 1. 00| 14| 24| 0. 75| 20| 20| 0. 50| 26| 16| 0. 25| 32| 12| a. Graph the demand curve and the supply curve b. Identify the equilibrium price and equilibrium quantity c. Assume a price of 1. 00, Identify if there is shortage or surplus in the market and how the market forces behave to reinstate the equilibrium d.Now assume the price is 0. 50 and repeat the question above e. Now assume this is the market behavior for an inferior good, what would happen if the consumers income would increase from $ 25 to $ 32 a week f. Assume this markets complementary good? s price increases, what would happen in this market g. Assume there is a rumor that the price for this good will increases in the following days. How do expectations affec t this market? What will be the final outcome? For all the questions above you must support your answer with a graph. 8.Price elasticity of demand : (0,1)/(-0,2) = -1,5 The demand is elastic and sensitive to price changes. 9. Price elasticity of demand : ((0,38-0,5)/0,5) = -0,24 -24% ((26000-10000)/10000) = 1,6 160% (-0,24)/(1,6) = -0,15 The demand is elastic and sensitive to price changes. 10. a. Vodka: luxury good or superior good, making a vodka more expensive can increase its perceived value as a luxury good to such an extent that sales can go up, rather than down. b. Table Salt: necessity good, necessity goods are usually produced by a  public utility.We can't live without and won't likely cut back on even when times are tough c. Furniture: normal good, this does not necessarily refer to the quality of the good, but an abnormal good would clearly not be in demand, except for possibly lower socioeconomic groups. d. Perfume: luxury good or superior good, making a perfume more e xpensive can increase its perceived value as a luxury good to such an extent that sales can go up, rather than down. e. Beet: inferior good, we can replace beet by others foodstuffs more expensive, better quality or that give more pleasure like a meat. f.Sugar: necessity good, necessity goods are usually produced by a  public utility. We can't live without and won't likely cut back on even when times are tough. 11. Decision making is based on costs and benefits. That means you make purchases if the marginal benefits are greater than the price. Thus, when you decide to make a purchase, you are likely receiving something worth more to you than what you had to spend to buy it, or else you wouldn’t have bought it. That net benefit, minus the equilibrium price, is consumer surplus. 12. GRAPH b. With a price of 4$, Bert buys 2 bottles.His CS for 2 bottles: (7-4) + (5-4) = 3 + 1 = 4$ c. With a price of 2$, Bert buys 3 bottles. His CS for 3 bottles: (7-2) + (5-2) + (3-2) = 9$ 13. G RAPH A price ceiling occurs when the government puts a legal limit on how high the price of a product can be. In order for a price ceiling to be effective, it must be set below the natural market equilibrium. When a price ceiling is set, a shortage occurs. A price floor is the lowest legal price a commodity can be sold at. Price floors are used by the government to prevent prices from being too low.For a price floor to be effective, it must be set above the equilibrium price. 14. a. 4P – 80 = 100 – 2P 6P = 180 P = 30$ Q = 40 The equilibrium price is 30$ and the equilibrium quantity is 40 bushels b. GRAPH c. (0. 5) x (20) x (40) = 400 $ Consumer surplus (0. 5) x (10) x (40) = 200 $ Producer surplus 400 + 200 = 600 $ Surplus Equilibrium 15. f. The difference between marginal utility and total utility The marginal utility of a good or service is the gain or loss from an increase or decrease in the consumption of that good or service.All goods and services have their own m arginal utility. The total utility is the sum of all marginal utilities for a good or service. Total utility is the aggregate sum of satisfaction or benefit that an individual gains from consuming a given amount of goods or services. The more the person consumes, the larger his or her total utility will be. g. The principle of diminishing marginal utility Diminishing marginal utility is to use or consume a good or service with the most important or efficient utility for us.

Corporate Financial Reporting and Taxation Essay

Corporate Financial Reporting and Taxation - Essay Example The year 2012 has been marked the company’s growth in the value of net assets. This, therefore, essay covers analysis of the company’s financial statements for the year 2012, risk of a possible corporate failure and the importance of the objectivity and integrity in the preparation of the financial statements (Financial Statement: the IP group, pp. 1-9). Return on capital employed (ROCE) – capital employed is total assets – current liabilities. Therefore, return on capital employed ratio indicates the return generated by every pound invested as capital employed. Concerning the IP group, the ROCE for the year was 15.5%. The interpretation of the ratio goes that in 2012, 15.5% of the company’s net profit was generated by the company’s capital employed. This ratio can also be used by investors to determine the required rate of return on investments. Generally, a lower return on capital employed than the cost of capital is not preferable to investors (Duncan Hughes, Asset management in theory and practice, pp. 42-44). Net profit margin – the ratio indicates a company’s financial health after meeting the cost of sales and the operating expenses. It also indicates the company’s ability to pay for future operating costs. Concerning the IP group, the ratio for 2012 was 77.5%. This means that in the year 2012, 77.5% % of the total revenue were net profit, whereas, the remaining 22.5% of sales were consumed by the company’s operating costs. From this analysis, it can be concluded that the level of operational efficiency for IP group was high due to the effective cost management strategy. (Sarngadharan M. & Kumar R. S. Financial analysis for management decisions, pp. 121-135). Net profit margin before tax – this ratio shows how well a company manages its operating expenses. The higher the ratio, the lower the operating expenses of a company. The opposite is true.

Custom Marketing Plan Coursework Example | Topics and Well Written Essays - 2250 words

Custom Marketing Plan - Coursework Example The company will target the market segments and is quite hopeful that sales growth will be observed. The individualistic culture in the USA (or absence of extended/joint family system) has increased the total number of households. Indeed, over 80% of the US population lives in urban areas where life is fast and people require small electronic appliances, which are categorized under necessities. Hence, the demand for electronic appliances is extremely higher because of better purchasing power of people in urban areas (indexmundi.com). For instance, Median household income in the USA is above $76,000 per annum; hence this shows the ability of consumers to buy appliances. In addition, people in the USA have an inclination towards products that ease their life thus huge demand for environment-friendly electronic appliances exists in USA (srds.com). 1) To produce and offer want-satisfying top quality electronic appliances to our potential consumers and to focus on value addition for segments with higher purchasing power. The sales would be increased by 200% in the first 3 years. 3) To ensure that our customers receive ‘Utility of Place’ and ‘Utility of Time’ through the effective supply chain and transportation networks. Special attention will be paid to avoid any artificial and unnecessary shortages in the market to maintain consumer confidence. 4) To enter the market with aggressive marketing and advertising strategies through the use of informative and persuasive advertising tactics. Electronic, Print, Radio and Internet Media will be used for promotion. Sales discounts will also be offered to entice potential wholesalers, retailers, and end-users.

Managing for Competitive Advantage Essay Example | Topics and Well Written Essays - 2500 words

Managing for Competitive Advantage - Essay Example t would be known as the Chip and PIN programme bringing banks, building societies and retailers together to combat the ever expansive problem of credit and debit card fraud. The trial began in fiscal year 2003 where cardholders would authorise purchases with the use of a Personal Identification Number (PIN) in place of their signature. (M&S Annual Review 2003 inside cover operating highlights) Year 2003 HR – Improvement in quality was managed in several ways including reconstitution of the store management structure including the presence of a store manager at each of the stores. Each of these store managers would have clear goals, responsibilities and accountability. There would be a field-based area management team offering the benefit of internal and external experience, which brings M&S in line with leading industry standards, thus providing a basis for further improvement in customer service, leadership and overall store standards. (M&S Annual Review 2003 inside cover operating highlights) Year 2003 Operations –There was increased market share in Women’s, Menswear and Lingerie with both strong product appeal and quality. The opening of thirteen Simply Food stores garnered 250,000 new customers shopping per week and the pilot program of the new credit and loyalty card proved successful with national roll-out in the second half of fiscal year 2003/2004. Considerations for the improvement of customer service involve potential for relocating the fitting rooms and the customer service within them. (M&S Annual Review 2003 inside cover operating highlights) Year 2003 Financial Management – The chairman, Luc Vandevelde, believes that â€Å"the key to regaining market share has been a focus on improving both the appeal and value of our products, thereby making aspirational quality more accessible to our customers, The Home programme opening just prior to the launch of the credit and loyalty card in Financial Services. During the fiscal year 2003 operating

Open Kitchen Article Example | Topics and Well Written Essays - 2500 words

Open Kitchen - Article Example The former is where all the kitchen activities and the myriad of objects usually in the kitchen is open for viewing of the general public - the consumer/s which comprised of families, couples, friends and just plain hungry people. Intuitively, we may think of the closed kitchen as a kitchen where the customers do not see the food and utensil preparation process. They have no idea of what is happening in the room separated from all other parts of the dining area of the restaurant because of the boundaries such as cement, wood or opaque glass. The question now that concerns us is whether to choose an open kitchen or not. As we will see later in this paper, both scenarios have their advantages and disadvantages for the labor side (chef and assistant cooks) and even for the consumer side (customers). However, we argue that one is more appropriate than the other. Such a claim needs backing and this is what the paper is precisely what this paper aims for - to offer points that can help the kitchen designer in deciding which is more effective, appealing, efficient and attractive for those waiting at the dining table. In the early days, cooking was mainly a public affair especially for the Greek and Roman soldiers who had their rations cooked in a large containers place over burning wood. (Harrison, 1972). However, with the amount of smoke generated and having slaves as their cooks, ensuing generations of food establishments, mostly bars and inns, progressively placed cooking in a separate room. Thus, the open kitchen now transformed to the close type. Describing Closed Kitchens Closed kitchens are spaces not open to the view of the customer. In this setting, cooks and their assistants conduct food preparations such as chopping, slicing and dicing. Stoves and ovens (which nowadays are combined in a single equipment) can be located at the sides or placed at the middle aisle which makes it more accessible to both sides thereby facilitating the cooking process and maximizing space. However, the latter configuration presents some danger especially during rush hours where accidents can occur. Refrigerators are placed at the sides as well as sinks and preparation tables. Some closed kitchens have the dishwashing area incorporated in the room while others have another connected extra room. Exhaust systems are usually placed above stoves to take out heat and smoke as fast as possible. Remember that several stoves and oven besides from blending and other equipments are emitting heat and this should be taken out as fast as possible so as not to further irritate the a lready stressed cook. (Kitchens.It, 2007) The settings in closed kitchen can get very busy and very chaotic. Nevertheless, the trained cook is expected to be able to deal with such situations. What is important to note, however, is that closed kitchens tend to get messy, noisy and smelly and the environment can sometimes get very tense. Figure 1 (a) and (b) presents two usual closed kitchen layouts. (a) (b) Figure 1: Closed kitchens where (a) food preparation is at the middle and (b) stoves occupy the middle setting Source: Google Open Kitchen Images (2007) Open Kitchen Layouts Since the kitchen is open to the public, designers make sure that there is not much dangling cooking utensils. Instead, these are arranged in the preparation table or are sometimes placed in drawers incorporated in t

Current policy intervention relevant to adult social care and its Essay

Current policy intervention relevant to adult social care and its impact on one of the groups - Essay Example The objective of this report is to define how the Valuing People white paper offers new opportunities while at the same time issuing solutions to existing problems in the implementation of the recommendations, so that adults with learning disabilities including their families can live complete and independent lives as part of their local communities. The report is aimed at the concerned government agencies and advocacy groups involved in implementing the white paper, particularly the National Health Service and the national Directorate of People with Learning Disabilities. The report covers the historical treatment of people with learning disabilities, especially how state sponsored care practises influenced the formulation of Valuing People policy intervention. Secondly, a critical evaluation of the white paper strengths and weaknesses on the wellbeing of people with disabilities is provided, based on existing literature, government reports and accounts of people undergoing the services offered under the policy intervention. The report uses various local learning disability services in England by evaluating their guidelines, policy implementation and practises. Finally, the report provides solutions to the weaknesses affecting the users of the services provided under the Valuing People intervention. A key limitation of the report is that, it did not interview in person individuals with learning disabilities, and as such these findings cannot be entirely generalized to the wider UK community. The De Prerogative Regis of 1334 was the first legal effort by the England crown state in administering community based care for individuals having learning disabilities (Puri, 2005, p.2) Even before the industrial revolution, the society did not recognize the fact that individuals with learning disabilities should be supported to live their own lives, as workers, parents, tenants or even home owners (Race, 2002, p. 24). Since they were

Quality control at Dubai metro Term Paper Example | Topics and Well Written Essays - 3500 words

Quality control at Dubai metro - Term Paper Example The strategic geographical location of Dubai in the Middle East has a significant role in the economic progress of the region. It is the central commercial indicator of the entire region in respect of the mass international economic and financial activities taking place in it. What is of particular interest is how quality control can be improved by the city’s management authorities. How operation management can effectively be put into play to see an improvement in overall performance of the city’s activities is the problem of central concernDubai Metro boasts of Arabian Gulf’s first major urban railway project that targets to boost the efficiency of movement amid various activities in the city. It has one of the finest urban rail systems in the globe which is responsible for the mass influx of tourists and serves as the avenue of economic and financial activities. The need for quality control is paramount in this commercial hub since the commercial activities tak en up are to be standardized at international level with complete adherence to the diverse cultural concepts that constitute the visitors. Operation management of this city is under the overall authority of Dubai Municipality’s Roads and Transport Authority (RTA) who has the supervisory role in all the quality control exercise in collaboration with central government authorities.It is important to assess the various concepts that surround the strategies that are put in place by the relevant authorizes in Dubai as far as quality control is concerned.... 1960, 32). Background information Dubai is one of the fast growing metros in the world with busy commercial activities that hinges on its vast infrastructural endowment and sound management. It is important to note that management of such metro cities is critical to the overall performance of the city (The Report, 2007, 124). The large volume of international trade in tangible and intangible commodities that is executed in this city calls for thorough quality control. This city therefore requires operation management team that is able to ensure that all the necessary social and economic conditions are satisfied. Dubai’s operation management teams are responsible for designing and managing the various products, underlying processes, supply chain and even the services to be tendered. The team headed by the city’s local authorities are in charge of overseeing acquisition of resources, their development and utilization so that various firms are able to deliver goods and ser vices to the multicultural client base that gets in and out of this United Arab Emirates city (Kachru, 2005, 636). Statement of the problem The strategic geographical location of Dubai in the Middle East has significant role in the economic progress of the region. It is the central commercial indicator of the entire region in respect of the mass international economic and financial activities taking place in it. What is of particular interest is how quality control can be improved by the city’s management authorities. How operation management can effectively be put into play to see an improvement in overall performance of the city’s activities is the problem of central concern

Explain the early development of the geocentric model of the universe Essay

Explain the early development of the geocentric model of the universe according to ancient greek cosmology - Essay Example Or else they are like the mind as it seeks mastery over the moving parts of its own body; or like a craftsman who does the best he can with whatever raw materials are available. The most influential thinker who had the most convincing notions of cosmology before Copernicus was Aristotle (384-322 B.C.). Aristotelian assumptions about place, space, matter, motion, and time served as the foundation for the Ptolemaic system, which dominated in the West for more than a thousand years. The plainness and unstrained authoritativeness of Aristotle's style may give us a glimpse into the sources, both rhetorical and philosophical, of his authority (Ross, 1930). Proposing the geocentric model of the universe, Aristotle focused his study on the earth's position, shape, and rest or motion as the center of the universe. His discussion by no means operates in a philosophical vacuum, but accounts briefly for other views in competition with his own. The line of argument is instructive for any who have imbibed the old clich, according to which geocentric cosmology is "said to locate the earth in the place of greatest importance in the universe." In Aristotle's geocentric model of the universe, each planet was attached to a transparent sphere of its own, and all spheres were turning round the earth.

Economic events in the period from Gorge W Bush to Obama Term Paper

Economic events in the period from Gorge W Bush to Obama - Term Paper Example The massive investment of the projects that do not have any return led to the lack of a proper balance sheet making the economy of the country shift downwards. The Obama administration came in when the effects of poor investment begin to get exposed. There was the hardship in the global economic crisis and any measure that the president took could not heal the economy instantly. He stated to work of the projects that would deliver in economic growth in the near future. The president was required to use extra allocations, and the tax rate was hiked to run these projects. The measure saw a lot of hardships to the peoples of the United States. The nationalists could even fail to afford some important amenities such as quality medical care. The Obama administration later engaged in this projects that could help the poor families in obtaining quality amenities at subsidized prices. The previous administration that was led by Bill Clinton is considered to have focused on the economic development. The economy of the largest country in the world is said to have improved in a much higher state. The investment and that savings that had been made by Clinton was later disrupted by the leadership policies of George Bush. Bush is highly blamed for misusing the country’s resources leading to the economic crisis in the country. Economists have argued that the two dominant political units in the country have different formulations of political policies and the difference in leadership is mostly focused around the economic growth. The view that former president George Bush was responsible for the financial crisis that was seen in the country and globally in 2008 is supported by a large margin in the country. Indeed, 50% of the citizens and economic analysts blames the administration on pushing the economy of the country to the wall. From these statistics, 38% of the population believes

Martinez Company Essay Example for Free

Martinez Company Essay Introduction Martinez Company is introducing a new product that may be manufactured by using either one of two methods, capital intensive, or labor intensive method. For the capital intensive method, the manufacturing costs per unit are; direct material at $5.00, direct labor at $6.00, variable overhead costs at $3.00 and fixed manufacturing costs at $2,508,000 for the period. For the labor intensive method costs per unit are; direct materials at $5.50, direct labor at $8.00, variable overhead costs at $4.50 and fixed manufacturing costs at $1,538,000 for the period. The research department of Martinez Company recommended an introductory unit sales price of $30. The selling expenses are approximately $502, 000 annually in addition to $2 for each unit sold regardless of the manufacturing method used. The second part of the research is to determine how many units the company will have to sell annually for both methods to be equal. To determine this number the company will need to calculate the indifference point. The calculation is the total fixed cost of both methods is subtracted and then  divided by the contribution margin per unit for each method. Indifference point = (3,010,000-2,040,000)/(14-10) = 242,500. So the company would have to sell 242,500 units for both methods to be equally profitable. This is good information because based on the manufacturing cost of each production method the company will have to sell a specific number of units to maximize profitability. Based on this number the company will select each method in accordance with the projected number of units to be sold. Capital-Intensive Manufacturing vs. Labor-Intensive Manufacturing In the future, the Martinez Company will need to use either capital-intensive or labor intensive method for production. Capital intensive manufacturing method focuses on a high level of capital investment, while labor intensive focuses on a high level of labor investment. Capital intensive manufacturing method is mostly used on a large scale production with automated processes. Labor intensive method is mostly likely used on smaller scale production with personalized products. The capital manufacturing method is also based on whether the organization is producing a standardized product or an exclusive product. The labor intensive manufacturing method should be used when a substantial amount of customer interaction is needed. Capital intensive manufacturing method can be used when the work is too dangerous for employees. With labor intensive manufacturing method there are lower fixed costs and higher variable costs. With the capital intensive manufacturing method there are higher fixed costs and variable costs. In this case, the capital intensive method would be the preferred choice if the sales are expected to be higher than the indifference number of $242,500. Capital intensive manufacturing method limits competition by serving as a barrier to entry and as a capital intensive business, the Martinez Corporation can benefit from this. Barriers to entry are obstacles that prevent new companies to function in capital-intensive industries. Capital intensive manufacturing minimizes human error resulting in a more effective and efficient productivity. Another great advantage with capital intensive manufacturing method is the minimal labor impact.

Gender and the Media Essay Example for Free

Gender and the Media Essay Socialisation is the way an identity is defined throughout life for a person. Children are seen a blank slate that is going to have a personality and roles set by the environment he lives in. A child generally has an idea on what gender they are by the time they are 2 years old. A boy will portray himself with the colour blue, would be very hyperactive and tend to bully girls. Females would be more mature, refer themselves to the colour pink and socialise with other girls, this is called primary socialisation. Personalities are defined through interactions with people that are close to them, there societys values and they learn the attributes of their sex at a young age and they know what is expected of them as a certain sex. The person is reinforced by social praise and punishment so the person can learn from mistakes and good deeds. Media has played a massive part on how socialisation as occurred to an individual. I am directly concerned with how the media affects young women within todays society, particularly through the use of gender stereotyping within young womens magazines, mainly through articles and advertisements. Here, the ideas and beliefs already created by the media are useful to advertisers because they are socially accepted ideologies. They know that they will influence women. It has been stated in the past that it is these media interpretations of The Perfect Woman that have been the cause for so many women becoming increasingly pressured into looking good and so dieting, keeping fit etc. This can, in extreme cases lead to serious psychological diseases such as anorexia and bulimia, where one of the main causes has been identified as social pressure. Society affects how people perceive themselves, Body Image awareness still exists in our society. Many people living on our society are influenced by the media and the fashion industry. Both are equally responsible for the increased number of people suffering from eating disorders. Fashion industries tend to only feature whose figures vary from eight to ten. Their androgynous waif-like figures are presented as representative of the everyday woman. In doing so the average woman in the street is forced to measure herself against an unrealistic ideal. Most models are above average height, have naturally lithe bodies and are aged between sixteen and thirty. Their image is constructed and manipulated by a predominately male homosexual industry which appears reluctant to show women as curvaceous individuals. Celebrities themselves fall foul of the dominant media representation of women. When society thinks of a family we automatically think of the nuclear family in which there is a mum, dad and often two or three children. This type is seen as the statistical norm until the 1980s where it was considered abnormal to deviate from this ideal family type and there were characteristics that came with this which were seen as socially acceptable. Children were seen as the outcome of a loving heterosexual couple and each person i. e. the mum and dad should have distinctive roles within the family. The mother should be concerned with motherhood and household chores. The father should protect the family and be a disciplinary role model, as well as their main role being defined as the breadwinner, this meaning they often bring in the most money. The mother should be the housekeeper who attians the house and looks after the children as they grow up. A young male would grow up learning the princilpes of the father and the young female would grow up adobting the mather principles. Post modernism shows that gender is the main topic in an individuals life as events that have occurred are directly linked to a individuals gender. Post modernism gives the individual more choice and that is the basis of post modernism, choice! The individual is more independent on their life choices; such old life ambitions of marriage and children are not compulsory but are a option that some people may seek. Unlike pre modernism and modernity where marriage and kids are ultimate goals and people automatically assume that this is the right path to follow. This gives way to new events that once were either not existent or unethical such as unisex and inter-racial marriages. It shows a deterioration of religion and supernatural belief, which leaves great division among people in identity and lifestyles. People are now working more flexible times, fashion has changed in such away that people can wear what they want, food is more oriental and music comes in a wide variety. Identity has separated into many huge groups such as social classes, ethnic group, age and gender. This leads to unrest to certain groups that want change as people now have a sense of spreading opinion and arguing their rights. Certain groups such as feminists, Marxist ideology and ageist rights. As choice and individual opinion now can be widely credited it gives chance for concern to be broadcasted such as the feminist supporters wanting females to be treated as equals among men. The first wave of feminism gave people the ideology in 1928 when they got the vote, which provoked the idea of gaining more such as the 2nd wave of feminism in the 1960s when women burned the bras, this caused great reasoning between the two gender differences. Karl Marx however says that society not the individual is the important issue as that eventually the working class will soon rule society. This radical change has brought in new changes such as the new man that is a unique gender that of a masculine and unemotional male, the new man focuses on his physical appearance and pays attention to diet, personality and self image, he is more emotional and doesnt fit in with a patriarchy idea. As post modernism has totally effected todays society it shows how an individual can make all the differences and how self concern and freedom is the new ideal but this idea could change and evidence suggests that it could lead to pre modernism of the old age as though it is a long term cycle of a society but critics say this is the final situation of society and the end solution is total equality among genders, races and age. This idea of choice could lead in any direction depending on current affairs within society yet time is not a important issue as this process could last a log time.