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

Performance management & Performance appraisal Essay

Nowadays, every company has their human resources department that plays a large part of an organizations and a key to affect business succeeds or not. There are two core threads of human resources department are individual and organizational learning, individual and organizational performance. Human resource management should possess a good management systems and framework; ensure human ability is all used to achieve organization goals. Include strategic human resources management, equal employment opportunity, staffing, talent management and development, total rewards, risk management and worker protection, employee and labor relations. The best organizations understand that managing human resources effectively involves more than focusing only on current employees. It requires a long-term perspective that is responsive to the concerns of current employees; potential future employees and recent employees no longer work for. At the same time, the organizations strive to manage employees effectually, face to many challenges, for instance manning teams, the multicultural workforce, globalization, ethics and corporate social responsibility and metros. Human resources department responsible to provide effectual performance management and system to assist the company is going smooth. Performance management The purpose of performance management is one of the most important and positive developments, achievement of high performance by the organization, managing the business. This is the process of identifying, measuring, managing and developing the performance in an organization. There are showing how well employees perform and finally improve performance level. The further explain that create strategic, integrated process, develop a culture of constantly success to organizations by improving the performance of the people who work in them and by developing the capabilities of individual contributors and teams (Cardy & Leonard , 2011). The development of individuals with competence and commitment, working towards to shared meaningful objectives within an organization that supports the achievement. When the direction is correctly, performance management is a systematic analysis and measurement of workers performance. Also it is a critical and necessary component for individual and organizational effectiveness. When manage a group of workers or others, report the feedback to boss. It must be a process needed for improvement to occur. In performance management, it is getting the right workers into the production line or suitable staff into the system in a very important part of the overall process (Bergstedt, 2010). Performance appraisal Performance appraisal are part of a performance management system, it is ongoing process of evaluating and reviews of employee performance over time. Provide an opportunity for formal communication between management and the employees, concerning each employee what performing on organization. Create two-way interaction between people. It is a good opportunity and let employee express what their comment to bosses is. Open lines of communication throughout the year help to make effective working relationships. Allow management to make decisions about employees within the organization from this communication. Appraisals to make evaluative decisions concerning the workforce including pay raises, promotions, demotions, training, and development and so on. It cans measures skills and realization with reasonable accuracy and uniformity. The management can depend on this reliable information for making strategic planning, may enhance productivity for the firm as well. It provides a way to help identify areas for performance enhancement and to help promote professional growth. Each employee is entitled to a thoughtful and careful appraisal (Harzing, Pinnington, 2011, p.20-28). The success of the process depends on the supervisor’s willingness to complete a constructive and objective appraisal and on the employee’s willingness to respond to constructive suggestions and to work with the supervisor to reach future goals. Difference between performance management and performance appraisal Performance management focus is on performance management, identifies measures, manages, and develops the performance of people in the organization. It is designed to improve worker performance over time. Emphasis is on performance improvements of individuals, teams and the organization. It will continue process with periodical performance review discussions and then performance planning, analysis, review, development and improvements. Defining and setting performance standards are an integral part and designed by the human resources department but monitored under the each departments. Developmental needs are identified in the beginning of the year on the basis of the competency requirements for the coming year. There is review via mechanisms. However performance appraisal focus is on performance appraisal and ratings. It is just a part of the performance management process. Identifies measures, evaluates the employee’s performance, and then discusses that performance with the employee. Normally it is an annual exercise though periodic evaluations are made. The main functions are on ratings and evaluation. The most important component is rewards and recognition of good performance of staff. Designed and monitored by the human resource department. Developmental needs are identified at the end of the year on the basis of the appraisal of competency gaps. There are review mechanisms to ensure objectivity in ratings. (Fraser, 2007) Characteristics of an unsuccessful performance management system Normally, the good performance possesses ability, motivation and opportunity. It should make use of employee skills and have adequate incentives to urge them willingness to do the job. Provide work in an environment with support and way for expression. Unfortunately, driven by the some situational constraints including physical environment, working conditions, use of outcome of appraisal complexity of job, interdependence and lack of financial or human resources to make performance management system be an unsuccessful (Armstrong & Baron, 2005, p. 78-85). Causes of Failure of a performance management system have legislation affirmative action, lack of raters, less training, rating inflation or deflation, unclear purpose, without or ignore feedback, unfair reward system, appraisal instruments, performance Standards, rating accuracy, accountability of raters, management Commitment, no trust and participation and acceptance. ( Luecke & Hall,2006, p.93-98) Characteristics of a successful performance management system Successful performance management system can manage performance over time to ensure that remain productive, and hopefully become even more capable, as progress in their careers. Designing an effective performance management system should including mirror the corporate culture, clear definition and communications of what good performance ensure all senior management support and understand the level of performance. It may train managers in this performance management. To set a clear expectation for employee, acknowledging that people are doing a good job and recognizing them for a job well done. To set a clear manifest that performance in the company is differentiated and that differences in performance are recognized through the reward system. Differentiate performance fairly and effectively; through actions to show poor performance is being address, high performance will have a great rewards. Set an expectations or employee development, adjust the system if needed. Even compete performance management have a well strategic, developmental and administrative, also need line managers and senior management behave in a same way and support. That would be accomplished to achieve the organization goals. (Roberts Alan, 2012) An unsuccessful versus a successful performance management system When an unsuccessful compare a successful performance management system, if under unsuccessful performance management system. Without any clear objective, goals and fair rules in this organization. The whole company will face to employee leave, low morale and not belong to the company. Without employee support and the bad relationship between company. The business must be going worst. On the contrary, if company has a good performance management system with a clear fairly and effectively goals, the employee and management will all support and try the best to achieve goals. The business will be getting better for each part under a pleased environment. (Bhattacharyya, 2011, p.47-52) Some common errors and eliminated The common errors including distributional errors occur in three forms, severity or strictness, central tendency and leniency. There are based on a standard normal distribution. In severity or strictness error, the rater evaluates everyone or nearly everyone. Similarity error occurs when raters evaluate subordinates that judge or consider more similar as better employees. All have a tendency to feel more comfortable with people who feel are more similar. The similarity is based on demographic characteristics such as race. Allow this feeling of comfort with similar individuals to be reflected in the performance appraisal process. It can avoid similarity error by embracing diversity and objectively evaluating individual employees based on their actual performance. Contrast error is the rater compares and contrasts performance between two employees, rather than using absolute measures of performance to measure each employee. For example, the rater may contrast a good performer with an outstanding performer, and as a result of the significant contrast. This would be a contrast error. It can avoid contrast error by objectively evaluating individual employees based on actual performance. Management must use the ranking method correctly; each individual based on the items on the assessment form then rank the individuals based on their assessments. Halo and horn occurs when the evaluator has a generally positive or negative impression of an individual, and the evaluator then artificially extends that general impression to many individual categories of performance to create an overall evaluation of the individual that is either positive or negative In other words, if employees are judged by their supervisor to be generally good employees, and the supervisor then evaluates each of the areas of their performance as good, regardless of any behaviors or results to the contrary, the supervisor is guilty of halo error. It can avoid halo error by remembering that employees are often strong in some areas and weaker in others, and need to objectively evaluate individual employees based on actual performance for each and every item of assessment. Appraisal politics is refers to evaluators purposefully contorting a rating to achieve personal or organization goals. Factors other than performance affect the performance appraisal. These factors are internal in the appraisal system and the organization system. It is occur when raters are accountable to the employee and rated, it appear competing rating goals and direct linking current between performance appraisal and most desirable rewards. In order to lessen this matter, managers should keep in mind and pay attention a fair appraisal system. Central tendency error occurs when raters evaluate everyone under the control as average nobody is either really good or really bad. Proximity error states that similar marks may be given to items that are near each other on the performance appraisal form, regardless of differences in performance on those measures. Regency error occurs when raters use only the last few weeks or month of a rating period as evidence of their ratings of others. Attribution error. In simplified terms, attribution is a process where an individual assumes reasons or motivations such as attitudes, values, or beliefs for an observed behavior. Reducing rater errors is offer reeducating rating errors. Rater training undertaken to make managers aware of rating errors and helps develop strategies for minimizing those errors. This is consisting of the participants view vignettes designed to elicit rating errors, for example contrast. Rater Error Training called frame-of-reference training as well, emphasize the multidimensional nature of performance and raters with the actual content of various performance dimensions. Moreover, accuracy training seems can increasing accuracy and provided the training allows raters to practice making ratings and training feedback. Create a fair system should include train raters on the appropriate use of the process as discussed previously, build top management support for the appraisal system and actively discourage distortion, give raters some latitude to customer performance objectives and criteria for their rates, recognize employee accomplishments that are not self-promoted, make sure constraints for example a budget. Also make sure that appraisal processes are consistent across the company and foster a climate of openness to encourage employees to be honest the weakness. (Salaman, Storey & Billsberry, 2005, p.19-27) Conclusion In conclusion, this essay is proving that good performance management is one of the most important positions in the company. Seeing that it can help employee and management together to achievement the goals under high performance. At the same time, human resources department is a very chief role to develop perfect performance management system and need to avoid some common error. Thus, that’s why human resources are a big part in the organization and influence the whole company. Word count: 2013 Reference Armstrong Michael & Baron Angela (2005): Managing Performance: Performance Management in Action, Chartered Institute of Personnel and Development, CIPD House London, p. 78-85 Bergstedt Martin, (2010) [online] Available at: http://chenected.aiche.org/tools-techniques/the-performance-appraisal-system-part-2-of-effective-employee-performance-management [Accessed October 27, 2012]. Bhattacharyya Dipak Kumar, (2011): Performance Management Systems and Strategies, Dorling Kindersley India Pvt Ltd, licensees of Pearson Education in South Asia p.47-52 Cardy Robert L & Leonard Brian, (2011): Performance Management: Concepts, Skills, and Exercises Second Edition, M.E.Sharpe, Inc New York, p.134-156 Fraser Ross, (2007) [online] Available at: [Accessed July 5 2007]. Harzing Anne-Wil, Pinnington Ashly, (2011): International Human Resources Management Third Edition, SAGE Publications Asia-Pacific Ltd Singapore p.20-28 Luecke Richard, Hall Brian J, (2006): Performance Management: Measure and Improve the Effectiveness of Your Employees, Harvard Business School Press p.93-98 Roberts Alan, (2012) [online] Available at: [Accessed June 25, 2012]. Salaman Graeme, Storey John, Billsberry Jon, (2005): Strategic Human Resource Management: Theory and Practice Second Edition, Published in association with The Open University p.19-27

Women's Rights in Australian Context Assignment Example | Topics and Well Written Essays - 750 words

Women's Rights in Australian Context - Assignment Example The 1970s and 1980s and some part of 1960s saw a second wave which was fundamentally directed at earning women rights equal to those enjoyed by men in Australia (skwirk.com.au, 2011). Importance of women’s rights in context of Australian politics: Women’s contribution can be seen as an integral part of almost all aspects of development in Australia. Despite their dedication and devotion for the development of Australian economy, culture and society, women in Australia had to overcome numerous social as well as institutional barriers in order to have their footprint marked on the Australian history. On the road to equality, Australian women have conventionally experienced tremendous setbacks along with some successes. This can be estimated from the fact that Australia was among the very first countries that provided women with the opportunity to be in the parliament and the right to vote. Yet, it is unfortunate that Australia did not appoint any female federal Cabinet-le vel minister until 1949 and the government required the female workers of the federal public service to resign upon marriage till the year 1966. Women experienced a tremendous social change in Australia in the two decades of 1970s and 1980s. â€Å"This period saw the emergence of articulate, politically focused women who campaigned in an organised way for equal pay, equal opportunity in education and the workplace, safe contraception, planned parenthood and adequate child-care facilities† (Department of Foreign Affairs and Trade, 2011). This period significantly improved the women’s status in Australia in comparison to men and the federal legislation had to put a ban on sex discrimination in 1984. Development of such reforms as pensions from the government for single mothers and childcare facilities followed. With the right to sit in the parliament and cast the vote, women’s rights are of huge significance to Australian politics. Besides, the way women have show ed up their strength in the 1970s and 1980s contains a lot of lessons for the political authorities in Australia. Current state of debate in Australia regarding women’s rights: People hold varying opinions regarding the influence of the women’s liberation movement upon the socioeconomic and political scenario of Australia. Although violence against women has gained increased recognition in Australia, yet women’s rights have still not fully been acknowledged. Today, Australian women have much more freedom of choice for reproduction unlike 1960s. Many women have gained important positions in both business and politics, though to achieve them, women still have to encounter much more challenges than men do. Women’s movement has done much to make most of the people acknowledge the equality of rights of men and women in Australia, but still little was done to alter the conventional roles of men and women in home. Women have much more opportunities today than th ey have had at any point in time in the past, yet women are still largely denied access to powerful positions in the organizations. More than 50 per cent of contemporary Australian population is women. Accordingly, more and more women have started to receive higher education. â€Å"In 2006, women accounted for 54.8 per cent of all tertiary education students and 47.5 per cent of all students enrolled in vocational education and training courses† (Department of Foreign Affairs and Trade, 2011). Most of the female students are studying food, management, nursing and commerce. Their representation in the engineering or building courses is not well up to the mark, with only 4.6 per cent of women entering these professions. Therefore, contemporary agencies are aware that not much

Letter of Advice to client Research Paper Example | Topics and Well Written Essays - 2000 words

Letter of Advice to client - Research Paper Example Of importance, landmark decisions will be central to the essay construction. The author will wrap up with a conclusion of the major findings. According to Stone1, consideration is mandatory in contract law to make agreements legally binding. It forms the test for enforceability of contracts. Its absence makes an agreement gratuitous and non enforceable as a contract. Estoppel is a claim in equity precluding someone from denying existence of a state of affairs if it would be unconscionable2 and the doctrine deals with pre-contractual waste by preventing adoption of positions at odds with previously relied upon positions by others3. Such denial might affect a person’s legal rights. Owen J. in The Bell Group Ltd v Westpac Banking Corporation4 defined estoppel as a: â€Å"†¦ doctrine designed to protect a party from the detriment that would flow from that party’s change of position if the assumption or expectation that led to it were to be rendered groundless by another.†1 In common law, the claimant had to prove existence of a contractual relationship in defense against a claim of non performance of contract. The requirement of consideration led to injustices which promissory estoppel sought to address. By preventing a promisor from reneging on promises without consideration, Handley AJA in Equititrust Ltd (formerly Equitiloan Ltd) v Franks4 noted that promissory estoppel dealt with equitably binding assurances restraining promisors from enforcing his legal rights. Estoppel can be traced to Denning J’s reasoning in Central London Property Trust Ltd v High Trees House Ltd5 which described estoppel ensuring justice and equity6 in holding a landlord to his undertaking to accept reduced rent. The defendant was estopped from demanding rent arrears for the period of the war due to scarcity of tenants7. Professor Atiyah8 states that consideration was classically a

Doha Development Round Essay Example | Topics and Well Written Essays - 1250 words

Doha Development Round - Essay Example To add to that, even USA and EU have strategic differences on certain issues. The most recent round, which was held in 2008, broke down after the member countries failed to reach a consensus regarding agriculture import rules (BBC, 2008). Though these were followed by intense negotiations, they failed to break the deadlock. The World Trade Organization was formed with an aim to supervise and liberalize international trade. The Doha round of talks was a devise formulated to achieve that aim and lower trade barriers around the world, thus facilitating growth in trade globally. Besides that, the talks were also meant to insure that multilateral trading system must benefit the developing countries that constitute over three quarters of WTO members. The Doha declaration declared that the member countries of the WTO should strive to negotiate a policy, wherein the developing countries manage to secure for themselves a share in the growth of world trade in accordance with their respective national economic growth. To achieve the above stated goals, the following twin means were identified- reducing import tariffs, thus allowing the developing countries to have wider access to the global markets, and discouraging domestic and export subsidies, which would enable the over-production of goods at very low prices. This in turn would again boost trade practices. The talks were centered around... Thus, the Doha declaration carefully worked on these strategies and elaborated a set of objectives with stipulated deadlines. The objective was to establish a fair and market-oriented trading system through a program of fundamental reforms. The program strengthened rules, and provided specific commitments on government support and protection for agriculture. The purpose was to correct and prevent restrictions and distortions in world agricultural markets. (WTO 2001). As has been discussed earlier, the major emphasis was on decreasing and eventually phasing out export subsidies, reducing support systems that pose a threat to trade relations, and broaden the limits of global markets, thus making them more accessible to the developing countries. Out of the 132 countries that are a part of the WTO, 103 countries are classified as developing or least developed. In majority of these countries, agriculture is the chief occupation for the masses. Thus, all possible steps were taken to ensure that developing countries benefit from the declaration, especially when it comes to the issue of agriculture. The issue was managed under the following dimensions- market access, domestic supports, export competition, and development issues. At certain places, these counties were also rendered special treatment, to alleviate domestic problems of food scarcity and rural development. Recently, however agriculture( more specifically, agriculture import rules) has become the crux of several deadlocks. The reforms were not limited to the agricultural sector alone. Negotiations were also carried out to implement tariff cutting schemes on major non agricultural

Distribution Channels and Strategies Research Paper

Distribution Channels and Strategies - Research Paper Example Logistics manage and govern various supply functions. Several activities form a part of logistics such as material handling and warehousing, inventory management, fleet and transportation management and hosts of other activities. Logistics bottleneck at any point may affect and strangulate the free movement of goods and in this sense, efficient and workable logistics is critical and necessary to keep distribution channel flooded with the goods so as to service consumer on time. Geographic location and area of coverage does affect the selection of distribution channels. Smaller the territory, fewer members in channel distribution can serve the purpose; however, as territory goes larger and distances increase, it becomes necessary to have more intermediate channel members for the efficient flow of goods. This also depends upon the nature of product that how fast the product is being consumed or whether it is perishable kind. The distribution channel would need more channel members alon g with proper logistics if the goods are fast moving and needs to be replenished in shorter duration so that channel does not go dry ever. Answer 2 There are two kinds of promotional strategies in marketing management and they are known as push and pull kinds of strategies to enhance sales of product or services. Push strategy uses very little or no advertising to get the products in the hands of consumer. In a push strategy, the company deploys their sales force and myriads of trade promotional means and ways to create demand for its product. Trade shows are most suitable places to push the product to the buyer. Push strategy is good when product is new and does not enjoy any brand loyalty; the market is flooded with many substitute products. Push strategy is also good when impulsive and unplanned buying is quite prevalent in the given product category. Push strategy also works well when consumer is well aware about the product. Dish washing detergents and other low-value products are good examples of push strategy. A push strategy is employed to sell the products or services directly to the customers bypassing entire distribution channel. Accordingly, push strategy is very well used in selling insurance products too. The characteristic of pull strategy is that it is directed toward consumers using a lot of promotional efforts such as coupons, free samples, and contests. In fact, pull strategy relies on high spending on advertisement and promotional means to create high consumer demand. Pull strategy works best when it is possible to differentiate the product with high brand loyalty in the chosen field. Usually, consumer involvement is also high in this category of products. The best example that can be given for pull strategy is the marketing efforts put by Proctor & Gamble in the marketing of personal care products such as creams, shampoos, lotions, sanitary napkins by providing free samples and coupons. Answer 3 ‘Noise’ can be defined as when too many advertising messages arrive in the market place regarding a product confusing the buyers to make their buying decisions. Consumers terminate these messages as 'noise' because they do not get any reliable and meaningful information necessary for their buying decisions. It is important to identify the situation that what is being conveyed in the marketplace and how seriously consumers take these messages. Any further messaging in the similar line will not evolve any favorable results

The International Business Environment Essay Example | Topics and Well Written Essays - 3750 words

The International Business Environment - Essay Example This research will begin with the statement that in the present state of the global economic situation, the concept of Foreign Direct Investment (FDI) has attracted significant attention both domestically and globally. As such, FDI has been regarded as a vital element to consider in evaluating the economic development of countries around the world, particularly developing ones. Different empirical studies reveal that the relationships that prevail between economic development and FDI are multifaceted. From a macro aspect, FDI indicators represent high productivity, employment situation, technological spillovers, and competitiveness. For the less developed countries, FDI represents access to international currencies and markets, higher exports, and a source of financing. Research shows that FDI plays a vital role in promoting local firms. The efforts that countries make to help them attract FDIs result from the positive influences they have in an economy. FDI boosts productivity, tran sfer of technology, know-how, managerial skills, unemployment reduction, international production systems, and access to foreign markets. In this case, FDIs should be considered as ways of realizing technological spillovers, which have the significant contribution to the growth of an economy as opposed to the case of national investments. This practice leads to advanced technologies’ spillovers to local enterprises. Conversely, FDI has the potential of crowding out local firms, leading to negative impact on the economic development of a country. Various researchers stipulate that the positive effects associated with FDI are few and that most of the resulting effects are negative. Though FDI is associated with particular positive effects, the relationship that prevails between them and economic development are inconsistent. The potential negative or positive effects resulting from FDI on an economy are also dependent on the sectors nature, in which an investment will be carrie d out. For instance, the benefits of mining and agricultural sectors are limited.

What made the Soviet experiment work, and what did eventually lead to Essay

What made the Soviet experiment work, and what did eventually lead to its failure - Essay Example This paper has presented a comprehensive account of the cause of the revolution. It has described how, a rush into a new system with very little knowledge and experience, coupled with other factors such as; conflicts within the parties, and the civil war; led to the failure of the soviet experiment. There is a description of the soviet experiment. Also included is a description of capitalism and its integration with the Russian economy, as well as, a description of socialism and its compatibility to the Russian economy. There is also a discussion about the qualities of the revolutionary leaders that led to the success and failure of the experiment, conflict between the two parties that formed the revolution, the civil war, and the outcome that led to the abandonment of socialism. All these have been described with reference to examples from historical texts and documents.Before 1914, Russia was a country of great wealth considering the farmed land estates that it had. These lands wer e however, inadequately used and there were millions of peasant farmers that grew poorer by the day due to increased population of industrial works, and high rents imposed on them by the landlords. The state of the economy of Russia was not good because of a variety of factors. Russia had no domestic market for its industrial products. The country had built a railway to be used to export products, and also invested largely on foreign capital.

Hyperspectral Remote Sensing Technology in Intelligent Buildings & Research Paper

Hyperspectral Remote Sensing Technology in Intelligent Buildings & Engineering - Research Paper Example In Intelligent Buildings & Engineering, Hyperspectral Remote Sensing Technology is primarily being used to provide an effective means of monitoring and analysis of various real-time data that can help enhance the operational efficiency and reduce costs and energy expenses of smart buildings thereby making them to be more comfortable, safe, and healthy as well as enhance the productivity of the occupants. Unlike multispectral imaging which normally deals with numerous images at discrete, narrow bands, Hyperspectral remote sensing is primarily based on narrow spectral bands produced over a continuous spectral range. This is critically important as it makes the images more detailed. One of the areas of intelligent building and engineering where hyoerspectral remote sensing imaging can be used is to make buildings safer and more comfortable by providing reliable geological and rock information, seismic and environmental data regarding the construction sites prior to the commencement of t he construction of the buildings. Generally, this is critically important in helping choose the appropriate building and engineering project designs as well as materials that best fit a particular geographical area.

Why and How are organizations out of Sync PT 2 Essay

Why and How are organizations out of Sync PT 2 - Essay Example The sole reason that resulted in one getting the given post can always lead us back to the type of manager on is. Basically, every person usually has a dream of being a boss one day and commanding other people to do their work. Once in managerial position, one can clearly see one that fits that position as having leadership qualities from the one who does not (Hickman, 2010). I believe that not all leaders are managers. It is possible to find someone who possesses leaders (Hickman, 2010)hip skills, but is not a manager. Leadership entails one who acts as a leader for others to follow. Leader commands respect and is held responsible for the other people’s affairs. Manager is people who are expected to have management skills in them. Though management and leadership go hand in hand, but in some cases may not. It is possible to have a manager who is not a leader and a leader who is not a manager (Hickman, 2010). In my personal experience while working in a certain private company, it happened that the manager in charge was a friend of the co-founder of the organization. Many workers in the company really disliked him as he always came up with rules to oppress the workers and make their lives in the company harder (Hickman, 2010). He always fired workers who annoyed him and knew that his actions were un-punishable. Looking at this example, this manager showed poor leadership skills (Hickman, 2010). He was unable to lead the people whom he was in charge and somehow abused his role as a manager for personal satisfaction. Leaders are people who place the desires of other people in front of themselves (Hickman, 2010). A true example of a leader is Mahatma Gandhi, who sacrificed his role as a prince to become a religious leader who had influence on the people. Leaders basically lead people towards a common goal, while managers are involved in organizing, controlling, planning

United States History Essay Example for Free

United States History Essay 1. Compare and contrast the U.S. experiences in World War I and World War II. War have become an inevitable part of the United States History. So far, the U.S. have engaged in numerous wars dating back to the civil war to the present Iraq war. However, it was in the First and Second World Wars that the U.S. had a major participation that resulted in the restoration of peace and order all over the globe. During World War I, the U. S. held a neutral stand for quite a long period during the early 1900s. At first, World War I was perceived by many Americans as a European conflict but when they realized that their economy and even the lives of some Americans were being adversely affected, they gradually shifted to a warring mode. At that time, U.S. economy was largely dependent on overseas trading but when the war broke out, it dramatically halted economic trading because they were no longer able to sell goods to other countries particularly to Britain and Germany. This event negatively influenced the economy of the United States. More so, the Americans became more agitated when the Germans attacked passenger ships that led to the death of numerous prominent Americans. However, it was the alliance between Mexico and Germany that triggered U.S. to be directly involved in the war because it imposed an imminent threat since Mexico was geographically close to American soil (Hardgrove United States Involvement in WWI). On the other hand, the U.S. participation to World War II had some similarities with their involvement during First World War. In both wars, U.S. started with a neutral stance but the intensity of their involvement in World War II was heightened because of the direct attack at Pearl Harbor. The entire period of WWI, U.S. was only at the sidelines that was carried on to the early part of WWII. At first, Americans aid was mostly confined at providing supplies to the allied forces through the Lend-Lease Act. But when Japan bombed Pearl Harbor and Germany and Italy declared war against the Americans, U.S. launched a massive offensive alongside with the British and Russians in Europe and Asia (Columbia Electronic Encyclopedia War comes to the United States). Clearly, U.S. involvement during World War II was more prevalent than in the First World War. Americans exhausted all their human and material resources during WWII to the point that it resulted to millions of casualties and thousands of deaths (Digital History Learn About World War II). 2. Explain how the Great Depression seemed to bring the U.S. to the brink of revolution and why you believe a revolution did or did not occur. The Great Depression was the time when the economy had an â€Å"immense disparity between U.S. productive capacity and the ability of Americans to consume.† At that time, the stock values at the New York Stock Exchange was at an all time low, many businesses have closed, several factories and banks have shut down. Also, there was a meager disposable income for an average American and the unemployment rate have catapulted ( Modern American Poetry The Depression in the United States). These were the economic consequences brought by the participation of the U.S. in WWI who became a â€Å"major creditor and financier of of postwar Europe.†Aside from the economic distress, depression also brought significant implications in the American political system. The presidential reign of Franklin Roosevelt allowed several modifications in the economy by increasing government regulation and massive public-works projects to facilitate rapid recovery. In spite of these initiatives, â⠂¬Å"mass unemployment and economic stagnation† persisted.( Modern American Poetry About the Great Depression) It seemed at this point that the Americans were already tired of waiting for the government to take bold actions in order for them to be instantaneously removed from the sinking hole of economic downfall. But the realization of the New Deal policies which focused on mitigating the effects of the depression and the outbreak of World War II have   hindered the possibility of having a revolt against the American government (Modern American Poetry The Depression in the United States). 3. How did World War II led to the Cold War and how was actual warfare between the U.S. and the U.S.S.R. avoided while the two powers competed? Prior to the WWII, the U.S. had illustrated the Soviet Union as   an evil nation but during the war, the two became allies because of their common enemy which were the Germans. However, their alliance was filled with doubts and distrusts that became very apparent at the end of the war. Actually, Gen. Patton, an American General, expressed his desire to lead the Allied army against the Soviet Red Army. More so, many were agitated particularly Americans and British when Gen. Eisenhower, Supreme head of the Allied Command, conceded to the demand of Stalin that the Red Army would be the first to invade Berlin. America was threatened of Stalins vast and powerful Red Army, while the Russians were very cautious of U.S. advance weapons capabilities. This relationship facilitated the emergence of the Cold War (Trueman What was the Cold War). Because of the Cold War, the world was divided into three main groups. The West which is   comprised of democratic countries while the East was spearheaded by the Union which is composed of communist countries (GlobaSecurity.org Cold War). Since both nations acknowledged each others competencies in the field of war, they opted to have a cold war to prevent a massive catastrophe from happening. They were both afraid of each others nuclear weapons in which if used, it could destroy the whole human population. So instead of directly fighting, Russia and the U.S. agitated each other through other means such as by supporting â€Å"conflicts in various parts of the globe† and by setting up a propaganda war against each other (GlobaSecurity.org Cold War). Both the U.S. and the Soviet Union used client states to forward their indirect war against each other. These client states are countries who fought for the the Americans and Russians on their behalf. Such as in the case of North and South Vietnam and Afghanistan. Americans supplied the anti-communist South Vietnam with weapons when they were at war with Communist North Vietnam who was on the other hand used weapons from the Soviet Union. Also,Afghan rebels were helpe d by the Americans when the Russian invaded their country in 1979 (Trueman What was the Cold War). 4. Explain how motion pictures are documents of American culture and society. Films are useful tools in understanding a particular culture. More so, Hollywood have dominated the global industry of movie-making. It is because of their status as the most powerful country in the world that projected them to be the front runners in this field. Furthermore, since many admire the American way of life, American filmmakers used this opportunity to showcase the American culture through movies. From then on, numerous films   were made that had an American-theme. An example would be the movie Reality Bites. This film is about the dilemmas that most college graduates experience such as looking for work or determining their purpose in life. Also, it depicted the American modern yuppie life in an urban setting. Another example is the movie Titanic. It showed the economic disparity between the rich and the poor of the American society. Though the setting was multicultural, it focused mainly on two American characters who were separated in love because of their different social status. These are just few samples that depict the American culture and society. Some of the themes adapted showed the typical suburban family life, the X generation lifestyle which is defined by technological gadgets and invention of new colloquial terms and others. Also, it seems that movie goers are entertained and at the same time educated by these American-oriented films. Most of the motion pictures produced by Hollywood utilizes American culture, society and history to impart to audiences from within and outside the U.S. the richness and distinctness of their knowledge,   customs and civilization. More so, it is a subtle way of reinforcing their socio-economic and political status as a powerhouse nation.