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Introduction. “The classic account of financial contagions presents a standard pattern in which speculative fevers are caused by the appearance of new, unusually profitable investment opportunities” what if one replaces “ unusually profitable investment opportunities” with “subprimes” ?.
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Introduction “The classic account of financial contagions presents a standard pattern in which speculative fevers are caused by the appearance of new, unusually profitable investment opportunities” • what if one replaces “unusually profitable investment opportunities” with “subprimes” ?
Defining crises how does a crisis work? (a) a new product appears (b) prices of the “new product” go up to unsustainable peaks (c) panic follows as investors sell assets, beginning with the “new product” (d) later passing to anything similar
Defining crises factors fostering/preventing the spread of a crisis: capital mobility fixed currency exchange rates financial regulation types of crises: banking crises currency crises
Rules and solutions to prevent or stop crises a relation between interpreting and solving crises needing a “lender of last resource” example: a central bank injecting liquidity fighting moral hazard with rules let the market go and learn the lesson
Rules and solutions to prevent or stop crises solutions should consider the type of crisis and the players concerned lender of last resource: usefull if economies involved are solid useless if economies involved are weak rules against moral hazard: usefull if economies involved are weak useless if economies involved are strong
Crises propagation: interdependance vs contagion crises may spread in two ways: (a) interdependence (b) contagion interdependence crisis naturally spreads to markets that are integrated price correlation of financial products in different markets is mostly determined by this integration
Crises propagation: interdependance vs contagion contagion requires the involvement of loosely integrated economies determines a faster and broader spread of the crisis price correlation overcomes any possible statistical distorsion
Financial crises, an historical overview looking for contagion in the historical record, from 1637 to 1997 evidence needed is rates correlation (covariance) among different markets, and different products: (short terms bank loans, bonds, equities …) seeking for the lessons learned
The first crisis: Amsterdam’s tulip mania (1636-1637) 1636-37, a “frenzy” determined by a new product: bulbs from China no contagion, and almost no propagation lessons learned: promoting lasting financial innovation
Two 18th century bubbles: Mississippi and South Sea 1719-20, speculation on shares of chartered joint-stock companies financial and monetary contagion of England, France and Amsterdam lessons learned vary: English boom of financial capitalism France step-back and Amsterdam decline
The first Latin American debt crisis (1825) 1825, a crisis caused by default of (some) Latin American countries 1820 Latin American bonds are more profitable than UK obligations a first flop on London market in 1825 followed by peaks in the fixing for unreliable countries (Peru, Chile) and a crash in 1828
The first Latin American debt crisis (1825) evidence of no contagion: (a) correlation among various “latin bonds” only before 1825 (b) correlation London stock-market index stops after 1825 drop lessons learned, in the UK: new law on bakruptcy, and more conservative monetary, and financial policies
Gold standard and its impact from 1870 the gold standard emerges currency and financial systems are more integrated than ever before interdependence becomes thus physiological, but what about contagion?
The 1873 panic: Germany and Austria 1873, a bubble based on French war reparations to Germany: stock-market collapse in Berlin and Vienna, plus contagion to Italy, Holland and USA, followed by a trade froze from data no evidence of contagion possibly because gold standard was not enforced
The first crisis in the era of the gold standard: 1890 Baring crack spring-october 1890, a bank crisis: Argentina’s default involves London Baring Bank and leads to a bank crisis in the USA limited contagion (USA and Russia) a lender of last resort and integration not yet complete lessons learned: coordination between central banks
The 1893 USA bank crisis 1893, a bank crisis that becomes a currency crisis a frame-work of increasing pressures on the gold standard evidence of contagion: only in 3 out of 12 cases shocks hit the core of the system
The 1907 panic 1907, lack of liquidity in NY market: (a) money for S.Francisco earthquake (b) UK denies the needed capitals (c) from NY the infection spreads in all financial centres of the world evidence of widerange contagion lessons learned: saving gold for WW I ?
The greatest financial crisis of all (1929-1934) before the crisis: “the five good years” (1924-1929) gold standard return a lower degree of protectionism remote cause of the crisis agricultural worldwide overproduction followed by a drop in prices
The greatest financial crisis of all (1929-1934) immediate cause october wall street crashes from stock market to credit: indebtment determines a lack of liquidity: “credit crunch” from USA to Europe a domino effect caused Europe indebtment with USA banks
The greatest financial crisis of all (1929-1934) effects of the crisis defaults in payments: (i) equities on credit, (ii) bank loans … credit crunch controls on capital exchange freeze of international trade
The greatest financial crisis of all (1929-1934) key-moments of a long-lasting crisis Wall street panic, October 1929 failure of Kreditanstalt in Austria, May 1931 UK quits the gold standard, September 1931 USA dollar devaluation, May 1933
The greatest financial crisis of all (1929-1934) a long-lasting crisis, a lender of last resort is lacking a widespread crisis, determined by banking interdependence in a context of feeble financial integration explains the paradox: no evidence of contagion
The greatest financial crisis of all (1929-1934) long lasting learning from the 1929 crisis: (1) usefulness of the lender of last resource (2) a relation between crisis’ propagation and interdependence
The post 1929-1934 scenario the 1930s: world is divided in trading (and financial) blocks sterling area, reichsmark block, East-Asia … the post WW II period: controls on capital flows (IFM, World Bank), and commodity market integration
The post 1929-1934 scenario results: a stable framework in which no global financial crises occur only currency crises locally confined problems: USA economic policy is constrained by its leadership the escape: the 1971 Nixon package
The New Financial Crises analysis of recent crises: no evidence of contagion the underlaying thesis: interdependence not contagion crises are the “tall to pay” for enjoying the benefits of integration 1929-34 an unrepeatable crisis
The New Financial Crises a typical pre-2008 crisis approach after 2008, a strong revision: 1929-34 is not exceptional uneven income distribution fosters both crises 2008 is perhaps the last episode of a long lasting bubble (at least from 2001)
