Hutchins Roundup: Corporate bonds, the opioid epidemic, and more

Studies in this week’s Hutchins Roundup find investment in corporate bond funds increases the fragility of the financial system, over-prescription, not unemployment and financial distress, is to blame for the opioid epidemic, and more.

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Investment in corporate Bond funds increases Risk of financial instability

The last decade has seen marked growth in mutual funds and exchange traded funds that hold illiquid securities, including corporate bonds. Antonio Falato at the Federal Reserve Board, Ali Hortacsu at the University of Chicago, and Itay Goldstein at the University of Pennsylvania argue that this has increased the fragility of the financial system. Using daily data on flows into and out of mutual funds and ETFs, the authors estimate that the average corporate bond fund and ETF experienced outflows of approximately 9% of net asset value between February and March 2020 at the onset of the COVID-19 pandemic and 6% between March and April. Funds holding illiquid assets fared much worse, experiencing average outflows of 19% between February and March and 15% between March and April. One reason for this difference is that when investors sell shares from funds holding illiquid assets, these funds must conduct costly liquidation, hurting the value of the entire fund. In anticipation of that, investors then rush to sell. The resulting fire sales, or sales of securities forced by redemptions, have spillover effects, reducing the valuation of peer funds holding the same securities. While the financial stress of the COVID-19 crisis was particularly severe for funds that were illiquid and vulnerable to fire sales, the authors find evidence that the Federal Reserve’s major policy interventions partly mitigated these effects.

Over-prescription, not unemployment and financial distress, is to blame for the opioid epidemic

Janet Currie at Princeton University and Hannes Schwandt at Northwestern University challenge research that links opioid use to an absence of economic opportunity and jobs. While unemployment is correlated to opioid abuse, it is not causally linked, they argue. Moreover, while African-Americans have higher unemployment rates than other Americans, the epidemic started among non-Hispanic whites, and most people addicted to opioids are employed. The geographic incidence of the epidemic does not align with areas experiencing structural changes in employment, nor does it follow business cycle fluctuations. There is more comprehensive evidence that physician over-prescription of opiates, spurred by changing attitudes towards pain, marketing by pharmaceutical companies, and little oversight of medical prescription, is to blame. The authors conclude that treatment of existing addiction, new guidelines for opiate prescriptions, and mandatory prescription drug monitoring programs are among the most effective policies to address the epidemic.

Continued unemployment insurance claims are more useful metric than initial claims

Despite press and financial-market focus on weekly reports of initial claims for unemployment insurance (UI) as a gauge of the effects of COVID-19 on the labor market, Tomaz Cajner and co-authors  at the Federal Reserve Board argue that continued UI claims (filed weekly or biweekly by individuals receiving benefits or awaiting a decision) track job losses more closely. The authors note that initial claims for baseline UI benefits, which exclude the expansion of benefits that Congress enacted due to the pandemic, are likely inaccurate due to the extraordinary influx of claims which caused processing delays and claim duplication on overloaded websites, in addition to increased fraudulent filing due to the federal UI supplement. Given that initial claims react only to employment losses and not gains, they posit this should be considered a plausible upper bound on the number of unemployed individuals. Conversely, continued UI claims cover those who remain unemployed and react to both employment losses and gains. They conclude that continued claims are a better indicator, after removing seasonal adjustment (which they argue is inappropriate during a “once-in-a-century” pandemic economic crisis) and adjusting for the handful of states that require biweekly as opposed to weekly filing.

Chart of the week: Unemployment insurance recipients as a share of the workforce by state

Quote of the week:

“[I]n March, I was hopeful that by June, we would look much more like many European countries. Unfortunately, that is not the case. And that means that whether we close down the economy or not—you see big differences in 55-year-old and over, and whether they’re going out, whether they’re spending. If you look at records of who’s going into stores, who’s going into restaurants, who’s going into bars, in most parts of the country, people over 55 are not doing that. That is an important group for spending,” says Eric Rosengren, President and CEO of the Federal Reserve Bank of Boston.

“When you think about leisure travel, when you think about restaurants, when you think about hotels, having that cohort worry about going out. Increasingly, as some states have found more severe problems, it becomes a problem for much younger individuals as well. At some point where hospitals are getting overwhelmed, people of all ages are going to say, ‘It’s too risky for me to go to a restaurant, to go to a bar, to go to a hotel, to get on a plane.’ And the longer people have that perception, the greater the risk to the economy, because those are all industries that employ a lot of people.”