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  • Browse content in O - Economic Development, Innovation, Technological Change, and Growth
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  • P37 - Legal Institutions; Illegal Behavior
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Article Contents

1. introduction, 2. key structural flaws of the new financial architecture, 3. conclusion.

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Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’

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James Crotty, Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’, Cambridge Journal of Economics , Volume 33, Issue 4, July 2009, Pages 563–580, https://doi.org/10.1093/cje/bep023

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We are in the midst of the worst financial crisis since the Great Depression. This crisis is the latest phase of the evolution of financial markets under the radical financial deregulation process that began in the late 1970s. This evolution has taken the form of cycles in which deregulation accompanied by rapid financial innovation stimulates powerful financial booms that end in crises. Governments respond to crises with bailouts that allow new expansions to begin. As a result, financial markets have become ever larger and financial crises have become more threatening to society, which forces governments to enact ever larger bailouts. This process culminated in the current global financial crisis, which is so deeply rooted that even unprecedented interventions by affected governments have, thus far, failed to contain it. In this paper we analyse the structural flaws in the financial system that helped bring on the current crisis and discuss prospects for financial reform.

In the aftermath of the financial collapse in the USA that began in 1929, it was almost universally believed that unregulated financial markets are inherently unstable, subject to fraud and manipulation by insiders, and capable of triggering deep economic crises and political and social unrest. To protect the country from these dangers, in the mid 1930s the US government created a strict financial regulatory system that worked effectively through the 1960s. These economic and political events found reflection in the financial market theories of endogenous financial instability created by John Maynard Keynes and Hyman Minsky. Their theories generated a policy perspective supportive of the sharp shift from light to tight financial market regulation that took place after the Great Crash. Economic and financial turbulence in the 1970s and early 1980s led to both a paradigm and a policy regime shift. Efficient financial market theory and new classical macro theory replaced the theoretical visions of Keynes and Minsky, and the existing system of tight financial regulation was deconstructed through radical deregulation pushed by financial institutions and justified by efficient financial market theory. These developments facilitated the transition to a new globally-integrated deregulated neoliberal capitalism. 1

The main thesis of this paper is that, although problems in the US subprime mortgage market triggered the current financial crisis, its deep cause on the financial side is to be found in the flawed institutions and practices of the current financial regime, often referred to as the New Financial Architecture (NFA). (While the global crisis clearly has both financial- and real-sector roots, this paper deals primarily with the former.) ‘New Financial Architecture’ refers to the integration of modern day financial markets with the era's light government regulation. After 1980, accelerated deregulation accompanied by rapid financial innovation stimulated powerful financial booms that always ended in crises. Governments responded with bailouts that allowed new expansions to begin. These in turn ended in crises, which triggered new bailouts. Over time, financial markets grew ever larger relative to the nonfinancial economy, important financial products became more complex, opaque and illiquid, and system-wide leverage exploded. As a result, financial crises became more threatening. This process culminated in the current crisis, which is so severe that it has pushed the global economy to the brink of depression. Fear of financial and economic collapse has induced unprecedented government rescue efforts that have been, to date, unable to end the crisis. In the next section of the paper we present a description of key structural flaws in the financial institutions and practices of the neoliberal era that helped generate the current crisis. This section is taken from a much more detailed analysis of these structural flaws (see Crotty, 2008 ).

2.1 The NFA is built on a very weak theoretical foundation

The NFA is based on light regulation of commercial banks, even lighter regulation of investment banks and little, if any, regulation of the ‘shadow banking system’—hedge and private equity funds and bank-created Special Investment Vehicles (SIVs). Support for lax regulation was reinforced by the central claim of neoclassical financial economics that capital markets price securities correctly with respect to expected risk and return. Buyers and sellers of financial securities were, it was argued, able to make optimal decisions that led to risk being held only by those capable of managing it. The celebratory narrative associated with the NFA states that relatively free financial markets minimise the possibility of financial crises and the need for government bailouts (see Volcker, 2008, for a summary of this narrative). Crotty (2008) explains that this theoretical cornerstone of the NFA is based on patently unrealistic assumptions and has no convincing empirical support. Thus, the ‘scientific’ foundation of the NFA is shockingly weak and its celebratory narrative is a fairy tale.

2.2 The NFA has widespread perverse incentives that create excessive risk, exacerbate booms and generate crises

The current financial system is riddled with perverse incentives that induce key personnel in virtually all important financial institutions—including commercial and investment banks, hedge and private equity funds, insurance companies and mutual and pension funds—to take excessive risk when financial markets are buoyant. 2 For example, the growth of mortgage securitisation generated fee income—to banks and mortgage brokers who sold the loans, investment bankers who packaged the loans into securities, banks and specialist institutions who serviced the securities and ratings agencies who gave them their seal of approval. Since fees do not have to be returned if the securities later suffer large losses, everyone involved had strong incentives to maximise the flow of loans through the system whether or not they were sound. Total fees from home sales and mortgage securitisation from 2003 to 2008 have been estimated at $2 trillion ( Financial Times , 2008C ).

Top investment bank traders and executives receive giant bonuses in years in which risk-taking generates high revenue and profits. Of course, profits and bonuses are maximised in the boom by maximising leverage, which in turn maximises risk. In 2006, Goldman Sachs’ bonus pool totaled $16 billion—an average bonus of $650,000 very unequally distributed across Goldman's 25,000 employees. Wall Street's top traders received bonuses of up to $50 million that year. In spite of the investment bank disasters of the second half of 2007, which saw Wall Street investment banks lose over $11 billion, the average bonus fell only 4.7%. In 2008 losses skyrocketed causing the five largest independent investment banks to lose their independence: two failed, one was taken over by a conglomerate, and two became bank holding companies to qualify them for bailout money. Yet Wall Street bonuses were over $18 billion—about what they were in the boom year of 2004 ( DiNapoli, 2009 ). Bonuses at Goldman are expected to average $570,000 in 2009 in the midst of the crisis ( New York Times , 2009F).

About 700 employees of Merrill Lynch received bonuses in excess of $1 million in 2008 from a total bonus pool of $3.6 billion, in spite of the fact that the firm lost $27 billion. The top four recipients alone received a total of $121 million while the top 14 got $249 million ( Wall Street Journal , 2009A ). Losses reported by Merrill totaled $35.8 billion in 2007 and 2008, enough to wipe out 11 years of earnings previously reported by the company. Yet for the 11-year period from 1997 to 2008, Merrill's board gave its chief executives alone more than $240 million in performance-based compensation ( New York Times , 2009A ).

One of the most egregious examples of perverse incentives can be found in insurance giant AIG's Financial Products unit. This division, which gambled on credit default swaps (CDSs), contributed substantially to AIG's rising profits in the boom. In 2008 the unit lost $40.5 billion. Though the US government owns 80% of AIG's shares and invested $180 billion in the corporation, AIG nevertheless paid the 377 members of the division a total of $220 million in bonuses for 2008, an average of over $500,000 per employee. Seven employees received more than $3 million each ( Wall Street Journal , 2009C ).

These examples show that it is rational for top financial firm operatives to take excessive risk in the bubble even if they understand that their decisions are likely to cause a crash in the intermediate future. Since they do not have to return their bubble-year bonuses when the inevitable crisis occurs and since they continue to receive substantial bonuses even in the crisis, they have a powerful incentive to pursue high-risk, high-leverage strategies.

Credit rating agencies were also infected by perverse incentives. Under Basle I rules, banks were required to hold 8% of core or tier-one capital against their total risk-weighted assets. Since ratings agencies determined the risk weights on many assets, they strongly influenced bank capital requirements. Under Basle II rules banks only needed a modest sliver of capital to support triple-A securities. High ratings thus meant less required capital, higher leverage, higher profit and higher bonuses. Moreover, important financial institutions are not permitted to hold assets with less than an AAA rating from one of the major rating companies. There was thus a strong demand for high ratings. Ratings agencies are paid by the investment banks whose products they rate. Their profits therefore depend on whether they keep these banks happy. In 2005, more than 40% of Moody's revenue came from rating securitised debt such as mortgage backed securities (MBSs) and collateralised debt obligations (CDOs). If one agency gave realistic assessments of the high risk associated with these securities while others did not, that firm would see its profit plummet. Thus, it made sense for investment banks to shop their securities around, looking for the agency that would give them the highest ratings, and it made sense for agencies to provide excessively optimistic ratings. 3 The recent global financial boom and crisis might not have occurred if perverse incentives had not induced credit rating agencies to give absurdly high ratings to illiquid, non-transparent, structured financial products such as MBSs, CDOs and collateralized loan obligations. 4

Reregulation of financial markets will not be effective unless it substantially reduces the perverse incentives that pervade the system.

2.3 Innovation created important financial products so complex and opaque they could not be priced correctly; they therefore lost liquidity when the boom ended

Financial innovation has proceeded to the point where important structured financial products are so complex that they are inherently non-transparent. They cannot be priced correctly, are not sold on markets and are illiquid. According to the Securities Industry and Financial Markets Association (SIFMA), there was $7.4 trillion worth of MBSs outstanding in the first quarter of 2008, more than double the amount outstanding in 2001. Over $500 billion dollars in CDOs were issued in both 2006 and 2007, up from $157 billion as recently as 2004 (SIFMA website). The explosion of these securities created large profits at giant financial institutions, but also destroyed the transparency necessary for any semblance of market efficiency. Indeed, the value of securities not sold on markets may exceed the value of securities that are. Eighty percent of the world's $680 trillion worth of derivatives are sold over-the-counter in private deals negotiated between an investment bank and one or more customers. Thus, the claim that competitive capital markets price risk optimally, which is the foundation of the NFA, does not apply even in principle to these securities.

Even with a mathematical approach to handling correlation, the complexity of calculating the expected default payment, which is what is needed to arrive at a CDO price, grows exponentially with an increasing number of reference assets [the original mortgages]… . As it turns out, it is hard to derive a generalized model or formula that handles this complex calculation while still being practical to use. ( Chacko et al. , 2006 , p. 226)

The relation between the value of a CDO and the value of its mortgages is complex and nonlinear. Significant changes in the value of underlying mortgages induce large and unpredictable movements in CDO values. Ratings agencies and the investment banks that create these securities rely on extremely complicated simulation models to price them. It can take a powerful computer several days to determine the price of a CDO. These models are unreliable and easily manipulated statistical black boxes. Given perverse incentives, it is not surprising that market insiders refer to the process through which CDOs are marked or priced as marking to ‘magic’ or to ‘myth’. New York University's Nouriel Roubini observed that CDOs ‘were new, exotic, complex, illiquid, marked-to-model rather than marked-to-market and misrated by the rating agencies. Who could then ever be able to correctly price or value a CDO cubed?’ ( Roubini, 2008 ).

Demand for CDOs was strong in the boom because buyers could borrow money cheaply, returns were high and the products carried top ratings. But when the housing boom ended and defaults increased, the fact that no one knew what these securities were worth caused demand and liquidity to evaporate and prices to plummet. The celebratory narrative of the NFA had assured investors this could not happen. Efficient market theory asserts that liquidity will always be available to support security prices. Charles Goodhart, former member of the Bank of England's Monetary Policy Committee, noted that the theory assured investors ‘that you can always obtain funding to hold assets … and that the … short-term wholesale market, the interbank markets, the asset-backed commercial paper market and so on, would always be open and you would always have access to them’ ( Goodhart, 2009 ). Yet when the crisis hit, CDOs could be sold, if at all, only at an enormous loss. It is estimated that by February 2009, almost half of all the CDOs ever issued had defaulted ( Financial Times , 2009B ). Defaults led to a 32% drop in the value of triple A rated CDOs composed of super-safe senior tranches and a 95% loss on triple A rated CDOs composed of mezzanine tranches ( Financial Times , 2007A ).

Innovation became so intense that it outran the comprehension of most ordinary bankers—not to mention regulators. As a result, not only is the financial system plagued with losses on a scale that nobody foresaw, but the pillars of faith on which this new financial capitalism were built have all but collapsed. ( Tett, 2009 )

2.4 The claim that commercial banks distributed almost all risky assets to capital markets and hedged whatever risk remained was false

The conventional view was that banks were not risky because, in contrast to the previous era when they held the loans they made, they now sold their loans to capital markets through securitisation in the new ‘originate and distribute’ banking model. Moreover, it was believed that banks hedged whatever risk remained through CDSs. Both these propositions turned out to be false. Banks kept risky products such as MBSs and CDOs for five reasons, none of which were considered in the NFA narrative about efficient capital markets.

First, to reduce moral hazard and convince potential investors that these securities were safe, banks often had to retain the riskiest part—the so-called ‘toxic waste’.

Second, CDOs were especially attractive assets for banks to keep since they could be held off-balance-sheet with no capital reserve requirements , a development discussed below.

Third, the rate of flow of these securities through banks was so great and the time lapse between a bank's receipt of a mortgage and the sale of the MBS or CDO of which it was a part was sufficiently long that at every point in time banks held or ‘warehoused’ substantial quantities of these securities. When demand for MBSs and CDOs collapsed, banks were left holding huge amounts of mortgages and mortgage-backed products they could not sell. Global CDO issuance fell from $177 billion in the first quarter of 2007 to less than $20 billion one year later, a drop of 84%. The collapse in the price of these products is the main source of the massive bank losses that are the driving force of the crisis.

Merrill Lynch was one of the two largest underwriters of CDOs in the 3 years leading up to the crisis. While Merrill Lynch had only $3.4 billion in CDO origination in 2003, in 2006 it posted $44 billion in CDO deals. Merrill's rainmakers became addicted to the fees that flowed from financing CDOs, which reached $700 million in 2006.

Merrill apparently made a pivotal—and reckless—decision. It bought big swaths of the AAA paper itself, loading the debt onto its own books… . The amounts were staggering. By the end of June, Merrill held $41 billion in subprime CDOs and subprime mortgage bonds. Since the average deal is between $1 billion and $1.5 billion, and the AAA debt is around 80% of each deal, Merrill must have been buying nearly all the top-rated debt from dozens of CDOs… . Merrill's $41 billion exposure to subprime paper was more than its entire shareholders’ equity of $38 billion. That this huge position went unhedged astonishes everyone on Wall Street… ( Fortune Magazine , 2007 , emphasis added). 5

Fourth, when banks found the safest or ‘super senior’ tranches of mortgage backed securities hard to sell because their yield was relatively low, they kept them themselves so that they could sustain the high rate of CDO sales that kept bonuses rising. In a comment about this practice that reflects both the power of perverse incentives and the destructive dimensions of financial market competition, Citigroup CEO Charles Prince said in July 2007: ‘When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing’ ( Financial Times , 2007C ).

Fifth, given banks’ incentive to generate high profits and bonuses through high risk, they purposely kept some of the riskiest products they created.

In 2007, the Bank of England called attention to the fact that large global banks were not slimming down as the ‘originate-and-distribute model’ predicted they would. Rather, on-balance-sheet assets had exploded from $10 trillion in 2000 to $23 trillion in 2006. The main cause of this asset growth was the incredible rise in bank holdings of MBSs and CDOs, the kinds of securities that banks were supposed to sell rather than hold in the narrative of the NFA. In April 2009, the International Monetary Fund (IMF) estimated potential losses in 2007–2010 from US-originated credit assets held by banks and others at $2.7 trillion ( IMF, 2009 , p. 27). Richardson and Roubini ‘suggest that total losses on loans made by U.S. banks and the fall in the market value of the assets they are holding will reach about $3.6 trillion. The U.S. banking sector is exposed to half that figure, or $1.8 trillion’ ( Richardson and Roubini, 2009 ).

Claims that banks hedged most risk through CDSs were equally shaky. Credit default swaps are derivatives that allow one party to insure against loss from loan defaults by paying insurance fees to another party. However, since the value of credit default swaps hit $62 trillion in December 2007, while the maximum value of debt that might conceivably be insured through these derivatives was $5 trillion, it was evident that massive speculation by banks and others was taking place. Fitch Ratings reported that 58% of banks that buy and sell credit derivatives acknowledged that ‘trading’ or gambling is their ‘dominant’ motivation for operating in this market, whereas less than 30% said that ‘hedging/credit risk management’ was their primary motive. This ‘confirms the transition of credit derivatives from a hedging vehicle to primarily another trading asset class’ ( FitchRatings , 2007 , p. 9). Eric Dinallo, the insurance superintendent for New York State, said that 80% of the estimated $62 trillion in CDSs outstanding in 2008 were speculative ( New York Times , 2009D ).

By 2007 the CDS market had turned into a gambling casino that eventually helped destroy insurance giant AIG and investment banks Bear Stearns and Lehman Brothers. As of February 2009 AIG alone had suffered losses of over $60 billion on CDS contracts ( Haldane, 2009 , p. 14.) No regulator objected when AIG guaranteed $440 billion worth of shaky securities with no capital set aside to protect against loss apparently because both the securities and AIG were triple A rated. The bonus-drenched ‘geniuses at A.I.G. who wrote the insurance were willing to bet more than double their company's value that defaults would not become problematic’ ( New York Times , 2009C ). A major reason that the government invested $180 billion to save AIG was to provide protection against losses that large US and foreign institutions would have incurred from their contracts with AIG had the company folded. Goldman Sachs received $12.9 billion and Merrill Lynch $7 billion, while 20 European banks received a total of $59 billion of US taxpayer money ( New York Times , 2009E ). This reflects moral hazard of the highest order. Firms like Goldman could gamble with confidence on risky CDOs only because they bought insurance from risk-laden AIG, who they knew was drastically under-capitalised. When they lost their bet on AIG, the public was forced to pay the bill because former Goldman Chief Executive Henry Paulson, acting in his capacity as Secretary of the Treasury, decided to rescue AIG even though he had previously let Lehman Brothers default (Paulson had to have known that Goldman would receive billions of dollars as the result of his decision). Though CDO prices had plunged, the government inexplicably paid banks their full face value. The regulators thus allowed the dominant financial firms and their top bonus recipients to engage in publicly subsidised win–win gambles.

Securitisation and the rise of CDSs did raise big-bank profits for many years, but they eventually created huge losses that more than wiped out the cumulative gains made over the long boom. As early as December 2007, Citigroup had ‘lost more money than it made from financial instruments based on U.S. subprime mortgages…’ ( Bloomberg , 2007 ).

2.5 Regulators allowed banks to hold assets off balance sheet with no capital required to support them

In the late 1990s, banks were allowed to hold risky securities off their balance sheets in SIVs with no capital required to support them. The regulatory system thus induced banks to move as much of their assets off-balance-sheet as possible. When the demand for risky financial products cooled off in mid 2007, bank-created off-balance-sheet SIVs became the buyer of last resort for the ocean of new MBSs and CDOs emanating from investment banks. At the end of 2007, J.P. Morgan Chase & Co. and Citigroup each had nearly $1 trillion in assets held off their books in special securitisation vehicles. For Citigroup this represented about half the bank's overall assets. ( Wall Street Journal , 2008 ). 7

SIVs were supposed to be stand-alone institutions that paid service fees to the originating banks, but to which the originating banks had no obligations or commitments. They borrowed short-term in the commercial paper market and used this money to buy long-term, illiquid but highly profitable securities such as CDOs—a very dangerous game. To enable this commercial paper to receive AAA ratings and thus low interest rates, originating banks had to provide their SIVs with guaranteed lines of credit. This made the banks vulnerable to problems experienced by their supposedly independent SIVs.

When problems in the housing market triggered a wave of subprime defaults, the value of MBSs and CDOs collapsed. This triggered a mass exodus from the asset-backed commercial paper market. US asset-backed commercial paper outstanding fell from $1.2 trillion in July 2007 to $840 billion by the year's end. With the disappearance of their major source of funding, banks were forced to move these damaged assets to their balance sheets. In late July 2008 analysts at Citigroup forecast that up to $5 trillion worth of assets might be forced back on to bank balance sheets ( Financial Times , 2008B ). Contrary to the assumed transparency of financial markets, until SIVs began to collapse very few experienced financial market professionals knew they existed. ‘“In spite of more than 30 years in the business, I was unaware of the extent of banks’ off-balance-sheet vehicles such as SIVs” Anthony Bolton, president of investments at Fidelity International, recently observed’ ( Tett, 2009 ).

The combination of bank write downs on assets held on-balance-sheet combined with devalued SIV assets that had to be moved back onto balance sheets severely eroded bank capital. This in turn forced banks to try to lower their risk by raising interest rates and cutting loans to other financial institutions and to households and nonfinancial businesses.

2.6 Regulators allowed giant banks to measure their own risk and set their own capital requirements. Given perverse incentives, this inevitably led to excessive risk-taking

Deregulation allowed financial conglomerates to become so large and complex that neither insiders nor outsiders could accurately evaluate their risk. The Bank for International Settlement told national regulators to allow banks to evaluate their own risk—and thus set their own capital requirements—through a statistical exercise based on historical data called Value at Risk (VAR). Government officials thus ceded to banks, as they had to ratings agencies, crucial aspects of regulatory power. VAR is an estimate of the highest possible loss in the value of a portfolio of securities over a fixed time interval with a specific statistical confidence level. The standard exercise calculates VAR under negative conditions likely to occur less than 5% of the time.

There are four fundamental flaws in this mode of risk assessment. First, there is no time period in which historical data can be used to generate a reliable estimate of current risk. If firms use data from the past year or less, as is standard practice, then during boom periods such as 2003 to mid 2007 VAR exercises will show that risk is minimal because defaults and capital losses on securities are low. Banks thus need to set aside only a small amount of capital against estimated risk, which allows them to aggressively expand leverage, which in turn accelerates security price increases. The chairman of the UK's Financial Services Authority said that VAR ‘fails to allow for the fact that historically low volatility may actually be an indication of irrationally low risk-aversion and therefore increased systemic risk’ ( Financial Time s, 2009A ). On the other hand, if data from past decades are used, the existence of past crises will raise estimated risk, but financial markets will have undergone such fundamental change that these estimates will bear no relation whatever to current risk.

Second, VAR models assume that security prices are generated by a normal distribution. In a normal distribution the likelihood that an observation many standard deviations beyond a 95% or even a 99% confidence interval will occur is infinitesimal. In fact, security prices follow a distribution in which the preponderance of observations are ‘normal’, but every five to ten years observations occur that are so far from the mean that they are virtually incompatible with the assumption of a normal distribution. Examples of this well-known ‘fat tail’ phenomenon include the precipitous drop in stock prices that took place in August 1987, the global crisis brought on by the collapse of the giant hedge fund Long Term Capital Management, the Asian crisis and the recent global stock market and CDO crash. In August 2007, two large hedge funds managed by Goldman Sachs collapsed, forcing Goldman to inject $3 billion into the funds. To explain why Goldman should not be held responsible for their collapse, chief financial officer David Viniar said ‘We were seeing things that were 25 standard deviation moves, several days in a row’ ( Financial Times , 2007B , p. 25). The Director for Financial Stability of the Bank of England noted that, under a normal distribution, ‘a 25-sigma event would be expected to occur once every 6×10 124 lives of the universe’ adding, tongue-in-cheek, that when he tried to calculate the probability of such an event occurring several days in a row, ‘the lights visibly dimmed over London’. Even a 7.3 standard deviation event should occur only once every 13 billion years ( Haldane, 2009 , p. 2). Allowing banks to estimate risk and set capital requirements on the assumption that large losses cannot happen left them vulnerable when the crisis erupted.

Third, the asset-price correlation matrix is a key determinant of measured VAR. The lower the correlation among security prices, the lower the portfolio's risk. VAR models assume that future asset price correlations will be similar to those of the recent past. However, in crises the historical correlation matrix loses all relation to actual asset price dynamics. Most prices fall together as investors run for liquidity and safety, and correlations invariably head toward one, as they did in the recent crisis. Again, actual risk is much higher than risk estimates from VAR exercises.

Fourth, the trillions of dollars in assets held off balance sheet were not included in VAR calculations ( Blankfein, 2009 ).

Reliance on VAR helped create the current crisis and left banks with woefully inadequate capital reserves when it broke out. A Financial Times editorial observed that ‘risk management models … were catastrophic’ ( Financial Times , 2008D ). The Financial Time ’s Gillian Tett concluded that ‘it was sheer madness for financiers ever to have relied so heavily on these VAR models during the first seven years of this decade’ ( Tett, 2008B ). VAR-determined capital requirement are just one of many possible examples of totally ineffective regulatory processes within the NFA. Financial markets were not just lightly regulated, such regulation as did exist was often ‘phantom’ regulation—ineffective by design.

The problems involved in risk management through VAR were apparent to everyone who understood even the outline of the procedure; you do not need specialist knowledge to spot them. I explained the problems associated with VAR in Crotty, 2007 , a paper written in 2006, well before the crisis developed. Yet only a few influential financial observers warned against the futility of standard risk management practices prior to the crisis because VAR-based risk assessment maximised bonuses. No one wanted to kill the goose that was laying golden eggs.

VAR was dangerous. It gave firms a false sense of complacency, because it ignored certain risks and relied heavily on past price movements. In some markets, VAR actually increased risk, because every trader assessed risk in the same flawed way. In other markets, traders [using different VAR models] calculated VAR measures that varied ‘by 14 times or more.’ … LTMC's VAR models had predicted that the fund's maximum daily loss would be in the tens of millions of dollars, and that it would not have collapsed in the lifetime of several billion universes. ( Partnoy, 2003 , p. 263)

2.7 Heavy reliance on complex financial products in a tightly integrated global financial system created channels of contagion that raised systemic risk

It was claimed that in the NFA, complex derivatives would allow the risk associated with securities to be divided into its component parts, such as interest rate and counter-party risk. Investors could buy only those risk segments they felt comfortable holding. And rather than concentrate in banks as in the ‘Golden Age’ financial system, it was argued, risk would be lightly sprinkled on agents all across the globe. Since markets price risk correctly, no one would be fooled into holding excessive risk, so systemic risk would be minimised. Then New York Fed Chairman, and current Secretary of the Treasury, Timothy Geithner stated in 2006: ‘In the financial system we have today, with less risk concentrated in banks, the probability of systemic financial crises may be lower than in traditional bank-centered financial systems’ ( Geithner, 2008 ). In 2006 the IMF proclaimed that the dispersion of credit risk ‘has helped to make the banking and overall financial system more resilient’ ( Tett, 2009 ).

There are major flaws in this argument. As Financial Times columnist Martin Wolf put it: ‘The proposition that sophisticated modern finance was able to transfer risk to those best able to manage it has failed. The paradigm is, instead, that risk has been transferred to those least able to understand it’ ( Wolf, 2009 ). First, and perhaps most important, it implicitly assumed that the NFA would not generate more total risk than the previous tightly-regulated bank-based regime, but only spread a given system-wide risk across more investors. However, the degree of system-wide risk associated with any financial regime is endogenous. The effect of regime change on systemic risk depends on the amount of real and financial risk it creates and the way it disperses that risk, factors strongly affected by the mode of regulation. The structure of the NFA inevitably created excessive risk.

Second, derivatives can be used to speculate as well as to hedge. In the boom, hedging via derivatives is relatively inexpensive, but financial institutions guided by perverse incentives do not want to accept the deductions from profit and the bonus pool that full hedging entails. ‘Why financial institutions don't hedge risk more adequately is no mystery. It … costs money and cuts into returns—and, of course, their fees’ ( Wall Street Journal , 2007A ). Conversely, after serious trouble hits financial markets, agents would like to hedge risk, but the cost becomes prohibitive. For example, to insure $10 million of Citigroup debt against default for 5 years through CDSs cost about $15,000 a year in May 2007, but $190,000 in February 2008. Moreover, a rise in the cost of hedging can occur quickly and unexpectedly. The cost of insuring Countrywide debt rose from $75,000 in early July 2007 to $230,000 one month later; it then jumped by $120,000 in just one day ( Wall Street Journal , 2007B ). By January 2008, the cost of insuring Countrywide's debt was $3 million up front and $500,000 annually.

Ironically, while the ability to hedge via derivatives can make an individual investor safer, it can simultaneously make the system riskier. For example, hedging often involves dynamic derivative trading strategies that rely on liquid continuous markets with low to moderate transactions costs. A typical dynamic hedge involves shorting the risky asset held and investing in a risk-free asset. The hedge adjusts whenever the asset price, interest rate or volatility changes, which they do continuously. Every time the asset price declines or volatility increases, the risky asset must be sold; this is what makes the hedge ‘dynamic’. When problems hit, price falls and volatility rises. Institutions with dynamic hedges must sell their risky assets, which accelerates the rate of price decrease, which in turn forces more hedged-asset sales. If many investors have made similar dynamic hedges and are selling, liquidity dries up and prices can free-fall.

Consider the role played by AIG in the exploding CDS market. Many institutions used CDSs to hedge against a loss in the value of their CDOs (one reason banks bought CDS protection is that it lowered their capital requirements). Insurers such as AIG piled up immense commitments to pay in the event of defaults or capital losses with little capital to back these commitments. When losses hit security markets AIG could not pay off its contracts; it became insolvent. 8 Had the government not put $180 billion into AIG, many large financial institutions around the world would have failed. Ultimately, CDSs made the system more fragile because they facilitated excessive risk-taking.

Third, the narrative insists that derivatives unbundle risk, dividing it into simpler segments. But in fact, sophisticated derivatives such as CDOs re-bundle risk in the most complicated and non-transparent ways: this is what financial engineering and structured derivative products do. 9 These derivatives also add substantial ‘embedded’ leverage to the underlying or primitive products to enhance investor profits. Das explains how layers of unseen leverage added to derivative products by investment bankers sold to Orange County California caused unforeseen catastrophic losses: ‘Greenspan had been right—risk had truly been unbundled. We had packaged it right back up and shoved it down the eager throats of the wealthy taxpayers of Orange County’ ( Das, 2006 , p. 50).

Fourth, the celebratory NFA narrative applauded globalisation of financial markets because it created channels of risk dispersion. But securitisation and funding via tightly integrated global capital markets simultaneously created channels of contagion in which a crisis that originated in one product in one location (US subprime mortgages) quickly spread to other products (US prime mortgages, MBSs, CDOs, home equity loans, loans to residential construction companies, credit cards, auto loans, monoline insurance and auction rate securities) and throughout the world. The complexity of the networks linking markets together created immense fragility in the system: ‘Complexity adds to the danger that any one part of the hyper-financial system can bring down the whole’ ( Financial Times , 2008A ).

New and complex instruments to transfer credit risks in combination with large banks engaging in an ‘originate and distribute’ business model have amplified the consequences of the undeniable excesses in the US mortgage market … In the end, the new instruments of credit risk-transfer distributed fear instead of risk. ( Weber, 2008 )

2.8 The NFA facilitated the growth of dangerously high system-wide leverage

As noted, structural flaws in the NFA created dangerous leverage throughout the financial system. Annual borrowing by US financial institutions as a percent of gross domestic product (GDP) jumped from 6.9% in 1997 to 12.8% a decade later.

From 1975 to 2003, the US Securities and Exchange Commission (SEC) limited investment bank leverage to 12 times capital. However, in 2004, under pressure from Goldman Sachs chairman and later Treasury Secretary Henry Paulson, it raised the acceptable leverage ratio to 40 times capital and made compliance voluntary ( Wall Street Watch , 2009 , p. 17). This allowed large investment banks to generate asset-to-equity ratios in the mid to upper 30s just before the crisis, with at least half of their borrowing in the form of overnight repos, money that could flee at the first hint of trouble. 10 With leverage rates this high, any serious fall in asset prices would trigger a dangerous deleveraging dynamic.

Commercial banks appeared to be adequately capitalised, but only because they over-estimated the value of on-balance-sheet assets while holding a high percentage of their most vulnerable assets hidden off-balance-sheet. In fact, they were excessively leveraged, as the crisis revealed. Many European banks had leverage ratios of 50 or more before the crisis ( Goodhart, 2009 ), while Citibank's and Bank of America's ratios were even higher ( Ferguson, 2008 ). By the end of 2008 many large banks had seen their equity position evaporate to the brink of insolvency and beyond. Only massive government bailouts kept these ‘zombie banks’ alive.

Rising leverage was facilitated in part by the easy money policies of the Fed. To avoid a deep financial crisis following the collapse of the late 1990s stock market and internet booms, the Fed began to cut short-term interest rates in late 2000 and continued to hold them at record lows through to mid-2004. Financial firms were thus able to borrow cheaply, which, under different circumstances, might have fueled a boom in productive capital investment. However, given perverse incentives in financial markets, the spectacular returns to financial risk-taking, and a sluggish real economy in which growth was sustained primarily through the impact of rising debt and financial wealth on aggregate demand, the additional funds were mostly used for speculative financial investment.

Increased leverage helped push the size of financial markets to unsustainable heights relative to the real economy. By 2007 the global financial system had become, to use Hyman Minsky's famous phrase, ‘financially fragile’. The term is usually applied to a cycle phase, but in this case the condition had become secular. Any serious deterioration in the cash flows required to sustain security prices could have triggered a dangerous de-leveraging process. Falling housing prices and rising mortgage defaults provided that trigger. By January 2009, housing prices had declined by almost 28% according to the Case–Shiller index and mortgage default rates rose steadily. Structured financial security price declines were stunning. One reason was that: ‘The leverage used to put [CDOs] together can amplify losses [in the downturn]. For example, a 4 percent loss in a mortgage backed security held by collateralized debt obligations can turn into almost a 40% loss to the holder of the CDO itself’ ( New York Times , 2007 ). New York Fed Chairman Timothy Geithner expressed concern about the destructive power of reverse leverage in May 2007: ‘As market participants move to protect themselves against further losses, by selling positions, requiring more margin, hedging against further declines, the shock is amplified and the brake becomes the accelerator’ ( Geithner, 2008 ).

The downward spiral was exacerbated by the role ratings agencies played in the regulatory system. Facing a wave of criticism for having led investors astray in the boom with overly optimistic ratings, agencies belatedly shifted assets to higher-risk categories in the crisis. A small rating downgrade can lead to a large increase in required capital; the relation is not linear. Banks therefore had to come up with more capital to support their assets. Banks were thus forced to sell assets into a collapsing market. Meanwhile, margin calls forced borrowers to sell securities. The de-leveraging process froze credit markets. Since modern nonfinancial business and household sectors run on credit, the shrinking availability and rising cost of borrowing led to a slowdown in economic growth that in turn worsened the global financial crisis. The NFA had finally brought the global economy to the edge of the abyss.

The past quarter century of deregulation and the globalisation of financial markets, combined with the rapid pace of financial innovation and the moral hazard caused by frequent government bailouts helped create conditions that led to this devastating financial crisis. The severity of the global financial crisis and the global economic recession that accompanied it demonstrate the utter bankruptcy of the deregulated global neoliberal financial system and the market fundamentalism it reflects. Many of its most influential supporters, including Alan Greenspan, have recanted. Senior Financial Times columnist Martin Wolf recently wrote: ‘The era of financial liberalisation has ended’ ( Wolf, 2009 ).

Several decades of deregulation and innovation grossly inflated the size of financial markets relative to the real economy. The value of all financial assets in the US grew from four times GDP in 1980 to ten times GDP in 2007. In 1981 household debt was 48% of GDP, while in 2007 it was 100%. Private sector debt was 123% of GDP in 1981 and 290% by late 2008. The financial sector has been in a leveraging frenzy: its debt rose from 22% of GDP in 1981 to 117% in late 2008. The share of corporate profits generated in the financial sector rose from 10% in the early 1980s to 40% in 2006, while its share of the stock market's value grew from 6% to 23%.

The scope and severity of the current crisis is a clear signal that the growth trajectory of financial markets in recent decades is unsustainable and must be reversed . It is not possible for the value of financial assets to remain so large relative to the real economy because the real economy cannot consistently generate the cash flows required to sustain such inflated financial claims. It is not economically efficient to have such large proportions of income and human and material resources captured by the financial sector. 11 Financial markets must be forced to shrink substantially relative to nonfinancial sectors, a process already initiated by the crisis, and the nontransparent, illiquid, complex securities that helped cause the financial collapse must be marginalised or banned.

Governments thus face a daunting challenge: they have to stop the financial collapse in the short run to prevent a global depression, while orchestrating a major overhaul and contraction of financial markets over the longer run . The US economy is especially vulnerable because growth over the past few decades has been driven largely by rising household spending on consumption and residential investment. Consumption as a percent of GDP was 63% in 1980, 67% in 1998 and 70% in 2008. Since real wages were stagnant and real family income growth was slow, rising household spending was increasingly driven by the combined effects of rising debt and the increase in household wealth created by stock market and housing booms. Household debt was 48% of GDP in 1985, about where it had been in 1965. But it grew to 66% by 1998, then accelerated to over 100% by late 2008.

This dynamic process has reversed direction in the crisis. The saving rate is rising rapidly as households repay debt and attempt to rebuild wealth to create a cushion against job and income loss. Meanwhile, wealth is evaporating. Stock and residential housing values in the US have dropped by more than a combined $15 trillion, a 24% decline from the 2007 peak of $64 trillion. 12 According to Robert Solow, as a result of these developments ‘we are looking at a potential drop in consumer spending of something like $650 billion a year’, which is far larger than the annual impact of President Obama's fiscal stimulus package ( Solow, 2009 ). Falling wealth along with deteriorating labour market conditions and declining business investment spending have caused aggregate demand to collapse. Governments have been wise to use public funds as a partial counterweight to the impact of falling private spending on aggregate demand. Indeed, more needs to be done in this regard. It was also sensible to use public money to slow the rate of financial collapse, though the US government in particular has been spectacularly inefficient in its financial intervention policies.

The financial-services industry is condemned to suffer a horrible contraction… . It is hard to believe that financial services create enough value to command such pre-eminence in the economy. ( The Economist , 2009 )

For such a transition to be effective, two difficult tasks must be accomplished. Efficient financial theory must be replaced as the guide to policy making by the more realistic theories associated with Keynes and Minsky, and domination of financial policy making by the Lords of Finance must end.

The design and implementation of the changes needed in financial markets is a political as much as an economic challenge. Unfortunately, most elected officials responsible for overseeing US financial markets have been strongly influenced by efficient market ideology and corrupted by campaign contributions and other emoluments lavished on them by financial corporations. Between 1998 and 2008, the financial sector spent $1.7 billion in federal election campaign contributions and $3.4 billion to lobby federal officials ( Wall Street Watch , 2009 , p. 17). Moreover, powerful appointed officials in the Treasury Department, the SEC, the Federal Reserve System and other agencies responsible for financial market oversight are often former employees of large financial institutions who return to their firms or lobby for them after their time in office ends. Their material interests are best served by letting financial corporations do as they please in a lightly regulated environment. We have, in the main, appointed foxes to guard our financial chickens.

Unfortunately, the people President Obama has selected to guide his administration's financial rescue and reregulation programmes are almost uniquely unqualified to accomplish the dual objectives of down-sizing financial markets and eliminating dangerous securities. Chief economic advisor Lawrence Summers is a former Treasury Secretary who in 1999 supported the repeal of the 1930s legislation that separated investment and commercial banking, thereby legalising the creation of giant financial conglomerates and dramatically increasing the share of the industry that was ‘too big to fail’. Uniting commercial bank deposit and loan operations with investment banks and hedge and private equity funds was dangerous, yet Summers applauded Congress for refusing to regulate ‘a system for the 21st century [that] will better enable American companies to compete in the new economy’ ( Labaton, 1999 ). When Congress considered regulating financial derivatives trading, including CDSs, Summers told Congress that consideration of such legislation ‘cast a shadow of regulatory uncertainty over an otherwise thriving market’ ( Wall Street Watch , 2009 , p. 44). 13 Current Treasury Secretary Geithner and Summers were both protégés of Robert Rubin, a former chairman of Goldman Sachs and former Treasury Secretary, and currently an influential advisor to President Obama. The proposal to regulate financial derivatives ‘was quashed by opposition from [Clinton's] Treasury Secretary Robert Rubin…’ ( Wall Street Watch , 2009 , p. 17).

As president of the New York Federal Reserve Bank, Geithner had responsibility for seeing that giant financial conglomerates such as Citigroup avoided excessive risk, a task at which he failed miserably. He neither restrained their risk-taking nor warned the public that they had become excessively risky. ‘Mr. Geithner's five years as president of the New York Fed [was] an era of unbridled and ultimately disastrous risk-taking by the financial industry’ in which he ‘forged unusually close relationships with executives of Wall Street's giant financial institutions’ ( Becker and Morgenson, 2009 ). Geithner also bears substantial responsibility for the inefficiency of the financial rescue operations undertaken to date. For example, much of the Troubled Asset Relief Program in effect used taxpayer money to finance bonuses for top bank employees and dividends for shareholders with no positive impact on financial market performance.

Between 1998 and 2008 Rubin was a top official at Citigroup, where he received a cumulative $150 million in compensation. His main impact on bank policy was to push for the kind of aggressive risk taking that crashed the firm. Rubin ‘believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman, and he pushed to bulk up the bank's high-growth fixed-income trading, including the CDO business’ ( New York Times , 2008 ).

At every stage, Geithner et al. have made it clear that they still have faith in the people who created the financial crisis—that they believe that all we have is a liquidity crisis that can be undone with a bit of financial engineering, that ‘governments do a bad job of running banks’ (as opposed, presumably, to the wonderful job the private bankers have done), that financial bailouts and guarantees should come with no strings attached. This was bad analysis, bad policy, and terrible politics. This administration, elected on the promise of change, has already managed, in an astonishingly short time, to create the impression that it's owned by the wheeler-dealers. ( Krugman, 2009 )

Until this administration adopts a radical change of course in its financial market policies, US and global financial markets are likely to remain fatally structurally flawed. 14

The ideas in this paper are drawn from Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture ( Crotty, 2008 ). Issues treated here are also addressed in other publications ( Crotty, 2009 ; Crotty and Epstein, 2009 ). I am grateful for research support from the Economics Department at UMASS through the Sheridan Scholars program and to Douglas Cliggott and Rob Parenteau for helpful advice.

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See Crotty (2002) for an explanation of the historical economic and political processes through which the neoliberal regime came to replace Golden Age institutions and practices.

An analysis of the effects of perverse incentives in different market segments is presented in Crotty, 2008 .

Ratings agencies also gave large investment banks like Lehman and Merrill Lynch solid investment grade ratings that allowed them to borrow cheaply. ‘It's almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. In pursuit of their own short-term earnings, [ratings agencies] did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it’ ( Lewis and Einhorn, 2009 ).

‘As late as April 5, 2007, one analyst at a major rating firm said their ratings model didn't capture “half” of a deal's risk…’ ( Wall Street Journal , 2009B ).

The collapse of Merrill Lynch resulted in the firing of chief executive Stan O'Neill. This episode demonstrates the power of perverse incentives: O'Neill received exit pay of $161 million for his part in destroying the firm.

Regulators simply accepted bankers’ assurance that they would sell these assets quickly: they did not check whether in fact this was true.

SIVs contributed to the non-transparency of financial markets. ‘The largest Citigroup SIV is Centauri Corp., which had $21 billion in outstanding debt as of February 2007… There is no mention of Centauri in its 2006 annual filing with the Securities and Exchange Commission’ ( Wall Street Journal , 2007C ).

‘AIG, due to its high credit rating, did not have to post collateral until it was downgraded. At that point, the collateral calls were so massive that they effectively made the insurance giant insolvent’ ( Financial Times , 2009D ).

See Bookstabber (2007) and Das (2006) for concrete examples of the risk- and complexity-augmenting properties of structured financial products.

Half of the spectacular rise in investment bank's return on equity in the four years leading up to the crisis was generated by higher leverage rather than smart investing, efficient innovation or even boom-induced capital gains on trading assets.

A study of the career choices of Harvard undergraduates found that the share entering banking and finance rose from less than 4% in the late 1960s to 23% in recent years ( New York Times , 2009B ).

Global financial assets have declined in value by $50 trillion ( Financial Times , 2009C ).

In 2008 Summers received $5.2 million for part-time service as an advisor to a hedge fund, and was paid $2.7 million for speaking appearances, including at banks such as Citigroup, Goldman Sachs and JP Morgan. Revelation of these facts ‘threatened to undermine public trust in the administration's economic plans’ ( Financial Times , 2009E ).

It is possible, but not likely, that Europe will act independently of the USA and aggressively reregulate their financial markets.

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The Global Financial Crisis in the USA and The Failure of Central Banks

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Financial Crisis

  • The Financial Crisis
  • Financial Data Tools

Articles and Papers

Monetary Policy and the Crisis

Historical perspectives on the crisis, what caused the crisis, the role of subprime mortgages.

  • Possible Solutions

Financial Crisis Articles & Papers: All Topics

The articles and papers listed here cover aspects of the financial crisis and represent a range of opinions and analysis. The Federal Reserve Bank of St. Louis does not endorse the views presented in these articles or papers.

The Crisis: An Overview

The "Surprising" Origin and Nature of Financial Crises: A Macroeconomic Policy Proposal by Ricardo J. Caballero and Pablo Kurlat in Federal Reserve Bank of Kansas City Symposium , August 2009

The authors discuss three key ingredients for severe finanical crises in developed financial markets. Then they offer a policy proposal of tradable insurance credits to address a systemic crisis.

Bank Lending During the Financial Crisis of 2008 by Victoria Ivashina and David Scharfstein in SSRN , December 2008

This paper documents that new loans to large borrowers fell by 37% during the peak period of the financial crisis (September-November 2008) relative to the prior three-month period and by 68% relative to the peak of the credit boom (Mar-May 2007). New lending for real investment (such as capital expenditures) fell to the same extent as new lendi...  

The Commercial Paper Market, the Fed, and the 2007-2009 Financial Crisis by Richard G. Anderson and Charles S. Gascon in Federal Reserve Bank of St. Louis Review , November 2009

Since its inception in the early nineteenth century, the U.S. commercial paper market has grown to become a key source of short-term funding for major businesses, with issuance averaging over $100 billion per day. In the fall of 2008, the commercial paper market achieved national prominence when increasing market stress caused some to fear that,...  

The Credit Crunch of 2007-2008: A Discussion of the Background, Market Reactions, and Policy Responses by Paul Mizen in Federal Reserve Bank of St. Louis Review , September 2008

This paper discusses the events surrounding the 2007-08 credit crunch. It highlights the period of exceptional macrostability, the global savings glut, and financial innovation in mortgage-backed securities as the precursors to the crisis. The credit crunch itself occurred when house prices fell and subprime mortgage defaults increased. These event...  

The Crisis: Basic Mechanisms, and Appropriate Policies by Olivier J. Blanchard in IMF Working Ppaer , April 2009

The purpose of this lecture is to look beyond the complex events that characterize the global financial and economic crisis, identify the basic mechanisms, and infer the policies needed to resolve the current crisis, as well as the policies needed to reduce the probability of similar events in the future.

Deciphering the Liquidity and Credit Crunch 2007-08 by Markus K. Brunnermeier in Journal of Economic Perspectives , November 2008

This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, Brunnermeier explains how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.

Economic Recovery and Balance Sheet Normalization by Narayana R. Kocherlakota in Federal Reserve Bank of Minneapolis , April 2010

Speech before the Minnesota Chamber of Commerce

The Economics of Bank Restructuring: Understanding the Options by Augustin Landier and Kenichi Ueda in IMF Staff Position Note , June 2009

Based on a simple framework, this note clarifies the economics behind bank restructuring and evaluates various restructuring options for systemically important banks. The note assumes that the government aims to reduce the probability of a bank’s default and keep the burden on taxpayers at a minimum. The note also acknowledges that the design of...  

Factors Affecting Efforts to Limit Payments to AIG Counterparties by Thomas C. Baxter Jr. in Federal Reserve Bank of New York , February 2010

Testimony before the Committee on Government Oversight and Reform, U.S. House of Representatives

Facts and Myths about the Financial Crisis of 2008 by V. V. Chari, Lawrence Christiano and Patrick J. Kehoe in Federal Reserve Bank of Minneapolis Working Paper , October 2008

This paper examines three claims about the way the financial crisis is affecting the economy as a whole and argues that all three claims are myths. It also presents three underappreciated facts about how the financial system intermediates funds between households and corporate businesses.

The Federal Reserve Bank of New York's Involvement with AIG by Thomas C. Baxter and Sarah J. Dahlgren in Federal Reserve Bank of New York , May 2010

Joint written testimony of Thomas C. Baxter and Sarah Dahlgren before the Congressional Oversight Panel, Washington, D.C.

The Federal Reserve's Balance Sheet by Ben S. Bernanke in Speech , April 2009

The Federal Reserve has taken a number of aggressive and creative policy actions, many of which are reflected in the size and composition of the Fed's balance sheet. Bernanke provides a brief guided tour of the Federal Reserve's balance sheet as an instructive way to discuss the Fed's policy strategy and some related issues.

The Financial Crisis: Toward an Explanation and Policy Response by Aaron Steelman and John A.Weinberg in Federal Reserve Bank of Richmond Annual Report 2008 , April 2009

The essay is divided into the four sections. First, what has happened in the financial markets. Second, why those events took place. Third, possible market imperfections that could produce turmoil in the financial markets and an assessment of the role they have played in this case. And, fourth, how policymakers should respond in these difficult and...  

Financial Turmoil and the Economy by Frederick Furlong and Simon Kwan in Federal Reserve Bank of San Francisco Annual Report 2008 , May 2009

An overview of the financial crisis.

The Global Recession by Craig P. Aubuchon and David C. Wheelock in Federal Reserve Bank of St. Louis Economic Synopses , May 2009

Presents information on the percentage of economies around the world that are in recession, and offers comparisons with previous economic declines.

The Global Roots of the Current Financial Crisis and its Implications for Regulations by Anil K. Kashyap, Raghuram Rajan and Jeremy Stein in 5th ECB Central Banking Conference , November 2008

Where did the current financial crisis come from? Who or what is to blame? How will it be resolved? How do we undertake reforms for the future? These are the questions this paper will seek to answer. The analysis will have three parts. The first is a rough and ready sketch of the global roots of this crisis. Second, the authors focus in a more d...  

Interest on Excess Reserves as a Monetary Policy Instrument: The Experience of Foreign Central Banks by David Bowman, Etienne Gagnon, and Mike Leahy in Board of Governors International Finance Discussion Papers , March 2010

This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tighteni...  

Lending Standards in Mortgage Markets by Carlos Garriga, in Federal Reserve Bank of St. Louis Economic Synopses , May 2009

Examines the mortgage denial rates by loan type as an indicator of loose lending standards.

Lessons Learned from the Financial Crisis by William C. Dudley in Speech , June 2009

In assessing the lessons of the past two years, Dudley focuses on five broad themes that are interrelated: Interconnectedness of the financial system; System dynamics—How does the system respond to shocks?; Incentives—Can we improve outcomes by changing incentives?; Transparency; How should central banks respond to asset bubbles?

Liquidity Risk, Credit Risk, and the Federal Reserve’s Responses to the Crisis by Asani Sarkar in Federal Reserve Bank of New York Staff Reports , September 2009

In responding to the severity and broad scope of the financial crisis that began in 2007, the Federal Reserve has made aggressive use of both traditional monetary policy instruments and innovative tools in an effort to provide liquidity. In this paper, the author examines the Fed’s actions in light of the underlying financial amplification mechanis...  

Looking Behind the Aggregates: A Reply to "Facts and Myths about the Financial Crisis of 2008" by Ethan Cohen-Cole, Burcu Duygan-Bump, Jose Fillat and Judit Montoriol-Garriga in Federal Reserve Bank of Boston Working Paper , November 2008

In reply to the FRB of Minneapolis article by Chari et al. (2008) the authors of this paper argue that to evaluate the four common claims about the impact of financial sector phenomena on the economy, (which the FRB Boston authors conclude are all myths), one needs to look at the underlying composition of financial aggregates. This article find ...  

A Minsky Meltdown: Lessons for Central Bankers by Janet Yellen in FRBSF Economic Letter , May 2009

In this essay, Federal Reserve Bank of San Francisco President Yellen reconsiders the notion of a 'Minsky Meltdown' and suggests that it is time to reconsider the notion that a central bank can not intervene in bubbles. Yellen also outlines her thoughts on supervisory and regulatory policies going forward, and the importance of varying capital req...  

Overview: Global Financial Crisis Spurs Unprecedented Policy Actions by Ingo Fender and Jacob Gyntelberg in BIS Quarterly Review , December 2008

A four-stage overview of the crisis. Market developments over the period under review went through four more or less distinct stages. Stage one, which led into the Lehman bankruptcy in mid-September, was marked by the takeover of two major US housing finance agencies by the authorities in the United States. Stage two encompassed the immediate impl...  

The Panic of 2007 by Gary B. Gorton in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System , October 2008

How did problems with subprime mortgages result in a systemic crisis, a panic? The ongoing Panic of 2007 is due to a loss of information about the location and size of risks of loss due to default on a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. Subprime mortgages are a financial...  

Preparing for a Smooth (Eventual) Exit by Brian P. Sack in Federal Reseve Bank of New York , March 2010

Remarks at the National Association for Business Economics Policy Conference, Arlington, Virginia

Putting the Financial Crisis and Lending Activity in a Broader Context by Kevin L. Kliesen in Federal Reserve Bank of St. Louis Economic Synopses , February 2009

This paper discusses how banks typically tighten credit standards and/or loan terms as the economy weakens and nonperforming loans increase. But an adverse shock from outside the financial sector can be just as important—such as a sharp increase in oil prices or a plunge in house prices.

The Response of the Federal Reserve to the Recent Banking and Financial Crisis by Randall S. Kroszner and William Melick in Chicago Booth School of Business Working Paper , December 2009

The authors present an account of the policy actions taken by the Fed, providing a narrative that brings together information that otherwise requires consulting a variety of sources. They also present a framework for thinking about the central bank policy response that gives the reader a means of organizing her own understanding of the response. A...  

The Role of Liquidity in Financial Crises by Franklin Allen and Elena Carletti in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System , September 2008

The purpose of this paper is to use insights from the academic literature on crises to understand the role of liquidity in the current crisis. Allen and Carletti focus on four of the crucial features of the crisis that they argue are related to liquidity provision. The first is the fall of the prices of AAA-rated tranches of securitized products be...  

Speculative Bubbles and Financial Crisis by Pengfei Wang and Yi Wen in Federal Reserve Bank of St. Louis Working Paper , July 2009

Why are asset prices so much more volatile and so often detached from their fundamental values? Why does the bursting of financial bubbles depress the real economy? This paper addresses these questions by constructing an in?nite-horizon heterogeneous agent general equilibrium model with speculative bubbles. We characterize conditions under which st...  

The Supervisory Capital Assessment Program--One Year Later by Ben S. Bernanke in Speech , May 2010

At the Federal Reserve Bank of Chicago 46th Annual Conference on Bank Structure and Competition, Chicago, Illinois

The Taylor Rule and the Practice of Central Banking by Pier Francesco Asso, George A. Kahn, and Robert Leeson in Federal Reserve Bank of Kansas City Working Paper , February 2010

The Taylor rule has revolutionized the way many policymakers at central banks think about monetary policy. It has framed policy actions as a systematic response to incoming information about economic conditions, as opposed to a period-by-period optimization problem. It has emphasized the importance of adjusting policy rates more than one-for-one in...  

Toward an Effective Resolution Regime for Large Financial Institutions by Daniel K. Tarullo in Board of Governors Speech , March 2010

At the Symposium on Building the Financial System of the 21st Century, Armonk, New York

A Word on the Economy (with audio) by Julie L. Stackhouse in Federal Reserve Bank of St. Louis Educational Resources , September 2009

A powerpoint slideshow describing the subprime mortgage meltdown and how it relates to the overall financial crisis. Updated September 2009

“How Central Should the Central Bank Be?” A Comment by Christopher J. Neely in Federal Reserve Bank of St. Louis Economic Synopses , April 2010

The Reserve Bank presidents are fully accountable to our democratic institutions and the decentralized structure promotes healthy debate on monetary policy and regulatory issues.

Actions to Restore Financial Stability: A summary of recent Federal Reserve initiatives by Niel Willardson in The Region (Minneapolis Fed) , December 2008

This article provides a summary of recent Federal Reserve initiatives designed to reestablish normal credit channels and flows in the wake of the current financial crisis.

Activist Fiscal Policy to Stabilize Economic Activity by Alan J. Auerbach and William G. Gale in Federal Reserve Bank of Kansas City Symposium , August 2009

This paper examines the effects of discretionary fiscal policy in the current financial crisis.

Alt-A: The Forgotten Segment of the Mortgage Market by Rajdeep Sengupta in Federal Reserve Bank of St. Louis Review , January 2010

This study presents a brief overview of the Alt-A mortgage market with the goal of outlining broad trends in the different borrower and mortgage characteristics of Alt-A market originations between 2000 and 2006. The paper also documents the default patterns of Alt-A mortgages in terms of the various borrower and mortgage characteristics over th...  

Asset Bubbles and the Implications for Central Bank Policy by William C. Dudley in Federal Reserve Bank of New York , April 2010

Remarks at The Economic Club of New York, New York City

An Autopsy of the U.S. Financial System: Accident, Suicide, or Negligent Homicide? by Ross Levine in Brown University Working Paper , April 2010

In this postmortem, I find that the design, implementation, and maintenance of financial policies during the period from 1996 through 2006 were primary causes of the financial system’s demise. The evidence is inconsistent with the view that the collapse of the financial system was caused only by the popping of the housing bubble and the herding ...  

Bank Exposure to Commercial Real Estate by Yuliya Demyanyk and Kent Cherny in Federal Reserve Bank of Cleveland Economic Trends , August 2009

As rising home foreclosures and delinquencies continue to undermine a financial and economic recovery, an increasing amount of attention is being paid to another corner of the property market: commercial real estate. This article discusses bank exposure to the commercial real estate market.

Bankers Acceptances and Unconventional Monetary Policy: FAQs by Richard G. Anderson in Federal Reserve Bank of St. Louis Economic Synopses , March 2009

An expansion and FAQ following on an earlier article ("Bankers Acceptances: Yesterday's Instrument to Re-Start Today's Credit Markets?"). Describes possible implementation of a Banker's Acceptances program at the Federal Reserve.

Bankers’ Acceptances: Yesterday’s Instrument to Restart Today's Credit Markets? by Richard G. Anderson in Federal Reserve Bank of St. Louis Economic Synopses , January 2009

This note suggests considering an old—not new—financial market instrument: bankers’ acceptances. Bankers’ acceptances are one of the world’s older financial instruments, used as early as the twelfth century. Bankers’ acceptances have a long history in the Federal Reserve. Bankers’ acceptances are an old idea whose time may have returned—but with c...  

Beyond the Crisis: Reflections on the Challenges by Terrence J. Checki in Federal Reserve Bank of New York Speech , December 2009

A discussion of the challenges facing the financial system and reform.

A Black Swan in the Money Market by John B. Taylor and John C. Williams in Federal Reserve Bank of San Francisco Working Paper , April 2008

At the center of the financial market crisis of 2007-2008 was a jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spread...  

Central Bank Exit Policies by Donald L. Kohn in Speech, Board of Governors , September 2009

Kohn briefly underlines some aspects of the Federal Reserve's framework for exiting the unusual policies put in place to ameliorate the effects of the financial turmoil of the past two years

Central Bank Response to the 2007-08 Financial Market Turbulence: Experiences and Lessons Drawn by Alexandre Chailloux, Simon Gray, Ulrich Klüh, Seiichi Shimizu, and Peter Stella in IMF Working Paper , September 2008

The paper reviews the policy response of major central banks during the 2007–08 financial market turbulence and suggests that there is scope for convergence among central bank operational frameworks through the adoption of those elements that proved most instrumental in calming markets. These include (i) rapid liquidity provision to a broad rang...  

Central Banks and Financial Crises by Willem H. Buiter in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System , August 2008

This paper draws lessons from the experience of the past year for the conduct of central banks in the pursuit of macroeconomic and financial stability. Macroeconomic stability is defined as either price stability or as price stability and sustainable output or employment growth. Financial stability refers to (1) the absence of asset price bubbles...  

Commercial Bank Lending Data during the Crisis: Handle with Care by Silvio Contessi and Hoda El-Ghazaly, in Federal Reserve Bank of St. Louis Economic Synopses , August 2009

A discussion of commercial bank lending data, inferences that can be drawn from the data, and some caveats about the data.

Confronting Too Big to Fail by Daniel K. Tarullo in Speech, Board of Governors , October 2009

Tarullo suggests that the reform process cannot be judged a success unless it substantially reduces systemic risk generally and, in particular, the too-big-to-fail problem. This speech addresses the task of forging an effective response to this problem

Conventional and Unconventional Monetary Policy by Vasco Cúrdia and Michael Woodford in Federal Reserve Bank of New York Staff Reports , November 2009

We extend a standard New Keynesian model both to incorporate heterogeneity in spending opportunities along with two sources of (potentially time-varying) credit spreads and to allow a role for the central bank’s balance sheet in determining equilibrium. We use the model to investigate the implications of imperfect financial intermediation for famil...  

Crisis and Responses: the Federal Reserve and the Financial Crisis of 2007-08 by Stephen G. Cecchetti in NBER Working Paper (requires subscription) , June 2008

Realizing that their traditional instruments were inadequate for responding to the crisis that began on 9 August 2007, Federal Reserve officials improvised. Beginning in mid-December 2007, they implemented a series of changes directed at ensuring that liquidity would be distributed to those institutions that needed it most. Conceptually, this me...  

The Curious Case of the U.S. Monetary Base by Richard G. Anderson in Federal Reserve Bank of St. Louis Regional Economist , July 2009

Recent increases in the monetary base are far greater than any previously in American history, surely a "noble experiment" in policymaking. Whether these policies can succeed—and without accelerating inflation—remains to be seen.

The Dependence of the Financial System on Central Bank and Government Support by Petra Gerlach in BIS Quarterly Review , March 2010

How much does the banking sector depend on public support? Utilisation of many support facilities has declined, due mainly to a fall in demand. Supply factors play a smaller, but not insignificant role, as governments and central banks have tightened the conditions on which certain support measures are available or have phased them out entirely. Ho...  

Do Central Bank Liquidity Facilities by Jens H. E. Christensen, Jose A. Lopez, and Glenn D. Rudebusch in Federal Reserve Bank of San Francisco Working Paper , June 2009

In response to the global financial crisis that started in August 2007, central banks provided extraordinary amounts of liquidity to the financial system. To investigate the effect of central bank liquidity facilities on term interbank lending rates, the authors estimate a six-factor arbitrage-free model of U.S. Treasury yields, financial corporate...  

The Economic Outlook and the Fed's Balance Sheet: The Issue of "How" versus "When" by William C. Dudley in Speech , July 2009

Dudley comments on the economy and the economic outlook—where we have been and where we may be going. He suggests that the balance of risks is still tilted toward weakness in growth and employment and not toward higher inflation. He also discusses the impact of the Federal Reserve’s lending facilities and purchase programs on the size of the Fed’s ...  

Economic Policy: Lessons from History by Ben S. Bernanke in Board of Governors Speech , April 2010

At the 43rd Annual Alexander Hamilton Awards Dinner, Center for the Study of the Presidency and Congress, Washington, D.C.

The Effect of the Term Auction Facility on the London Inter-Bank Offered Rate by James McAndrews, Asani Sarkar and Zhenyu Wang in Federal Reserve Bank of New York Staff Report , July 2008

This paper examines the effects of the Federal Reserve’s Term Auction Facility (TAF) on the London Inter-Bank Offered Rate (LIBOR). The particular question investigated is whether the announcements and operations of the TAF are associated with downward shifts of the LIBOR; such an association would provide one indication of the efficacy of the TAF ...  

Effective Practices in Crisis Resolution and the Case of Sweden by O. Emre Ergungor and Kent Cherny in Federal Reserve Bank of Cleveland Economic Commentary , February 2009

The current fi nancial crisis is a painful reminder that the developed world is not yet immune to these devastating shocks. But while we haven’t learned to prevent them, we have learned some lessons about what is necessary to contain them once they begin and to limit the damage that follows. As policymakers worldwide focus on resolving the current ...  

The Fed as Lender of Last Resort by James B. Bullard in Federal Reserve Bank of St. Louis Regional Economist , January 2009

Because our central bank has relied on the federal funds rate target for so long to guide the economy, many people think that the target rate is the only tool at the Fed’s disposal. As we are seeing in the current financial crisis, the Fed has other options. Most visible so far have been the lending programs that have been created in the past year,...  

The Fed's Response to the Credit Crunch by Craig P. Aubuchon in Federal Reserve Bank of St. Louis Econoimc Synopses , January 2009

The Federal Reserve Board has used Section 13(3) of the Federal Reserve Act to create several new lending facilities to address the ongoing strains in the credit market.

The Fed, Liquidity, and Credit Allocation by Daniel Thornton in Federal Reserve Bank of St. Louis Review , January 2009

The current financial turmoil has generated considerable discussion of liquidity. Moreover, it has been widely reported that the Federal Reserve played a major role in supplying liquidity to financial markets during this distressed time. This article describes two ways in which the Fed has supplied liquidity since late 2007. The first is traditiona...  

The Federal Reserve as Lender of Last Resort during the Panic of 2008 by Kenneth N. Kuttner in Committee on Capital Markets Regulation Report , December 2008

This report examines the impact of the Fed’s unprecedented lending on its formulation and implementation of monetary policy. The first section provides some background on the Fed’s recent actions within the context of its role as lender of last resort (LOLR). The second outlines some of the ways in which the surge in Fed lending has affected the...  

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Federal Reserve Assets: Understanding the Pieces of the Pie by Charles S. Gascon in Federal Reserve Bank of St. Louis Economic Synopses , March 2009

This paper examines the composition of assets on the Fed’s balance sheet and groups them according to the objectives of the programs used to acquire them.

The Federal Reserve's Balance Sheet: An Update by Ben S. Bernanke in Speech, Board of Governors , October 2009

Bernanke reviews the most important elements of the Federal Reserve's balance sheet, as well as some aspects of their evolution over time. With this, he explains the steps the Federal Reserve has taken, beyond conventional interest rate reductions, to mitigate the financial crisis and the recession, as well as how those actions will be reversed as ...  

Federal Reserve's exit strategy by Ben S. Bernanke in Board of Governors Testimony , February 2010

Statement before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. as prepared for delivery. The hearing was postponed due to inclement weather.

The Federal Reserve's Term Auction Facility by Olivier Armantier, Sandra Krieger and James McAndrews in Federal Reserve Bank of New York: Current Issues in Economics and Finance , July 2008

As liquidity conditions in the term funding markets grew increasingly strained in late 2007, the Federal Reserve began making funds available directly to banks through a new tool, the Term Auction Facility (TAF). The facility is designed to improve liquidity by making it easier for sound institutions to borrow when the markets are not operating ...  

The Federal Reserve’s Commercial Paper Funding Facility by Tobias Adrian, Karin Kimbrough, and Dina Marchioni in Federal Reserve Bank of New York Staff Reports , January 2010

The Federal Reserve created the Commercial Paper Funding Facility (CPFF) in the midst of severe disruptions in money markets following the bankruptcy of Lehman Brothers on September 15, 2008. The CPFF finances the purchase of highly rated unsecured and asset-backed commercial paper from eligible issuers via primary dealers. The facility is a liquid...  

Financial Crises and Bank Failures: A Review of Prediction Methods by Yuliya Demyanyk and Iftekhar Hasan in Federal Reserve Bank of Cleveland Working Paper , June 2009

In this article the authors analyze financial and economic circumstances associated with the U.S. subprime mortgage crisis and the global financial turmoil that has led to severe crises in many countries. They suggest that the level of cross-border holdings of long-term securities between the United States and the rest of the world may indicate...  

The Financial Crisis: An Inside View by Phillip Swagel in Brookings Papers on Economic Activity , April 2009

This paper reviews the events associated with the credit market disruption that began in August 2007 and developed into a full-blown crisis in the fall of 2008. This is necessarily an incomplete history: the paper is being written in the months immediately after Swagel left Treasury, where he served as Assistant Secretary for Economic Policy from D...  

Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008 by Maurice Obstfeld, Jay C. Shambaugh and Alan M. Taylor in AEA Presentation Paper , December 2008

In this paper the authors connect the events of the last twelve months, “the Panic of 2008” as it has been called, to the demand for international reserves. In previous work, the authors have shown that international reserve demand can be rationalized by a central bank’s desire to backstop the broad money supply to avert the possibility of an in...  

Financial Intermediaries, Financial Stability and Monetary Policy by Tobias Adrian and Hyun Song Shin in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System , September 2008

In a market-based financial system, banking and capital market developments are inseparable. Adrian and Shin document evidence that balance sheets of market-based financial intermediaries provide a window on the transmission of monetary policy through capital market conditions. Short-term interest rates are determinants of the cost of leverage and ...  

Focusing on Bank Interest Rate Risk Exposure by Donald L. Kohn in Board of Governors Speech , January 2010

At the Federal Deposit Insurance Corporation's Symposium on Interest Rate Risk Management, Arlington, Virginia

A Framework for Assessing the Systemic Risk of Major Financial Institutions by Xin Huang, Hao Zhou, and Haibin Zhu in Federal Reserve Board, Finance and Economics Discussion Series , September 2009

In this paper the authors propose a framework for measuring and stress testing the systemic risk of a group of major financial institutions. The systemic risk is measured by the price of insurance against financial distress, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations. Imp...  

Further Results on a Black Swan in the Money Market by John B. Taylor and John C. Williams in Stanford University Working Paper , May 2008

Using alternative measures of term lending rates and counterparty risk and a wide variety of econometric specifications, we find that counterparty risk has a robust significant effect on interest rate spreads in the term inter-bank loan markets. In contrast, we do not find comparably robust evidence of significant negative effects of the Fed’s t...  

Getting Back on Track: Macroeconomic Policy Lessons from the Financial Crisis by John B. Taylor in Federal Reserve Bank of St. Louis Review , May 2010

This article reviews the role of monetary and fiscal policy in the financial crisis and draws lessons for future macroeconomic policy. It shows that policy deviated from what had worked well in the previous two decades by becoming more interventionist, less rules-based, and less predictable. The policy implications are thus that policy should “g...  

Government assistance to AIG by Scott G. Alvarez in Testimony before the Congressional Oversight Panel, U.S. Congress , May 2010

Housing, Mortgage Markets, and Foreclosures at the Federal Reserve System Conference on Housing and Mortgage Markets, Washington, D.C. by Ben Bernanke in Speech , December 2008

Housing and housing finance played a central role in precipitating the current crisis. Declining house prices, delinquencies and foreclosures, and strains in mortgage markets are now symptoms as well as causes of our general financial and economic difficulties. The most effective approach very likely will involve a full range of coordinated measu...  

How Did a Domestic Housing Slump Turn into a Global Financial Crisis? by Steven B. Kamin and Laurie Pounder DeMarco in Board of Governors International Finance Discussion Papers , January 2010

The global financial crisis clearly started with problems in the U.S. subprime sector and spread across the world from there. But was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? To answer this question, we assessed whether countr...  

How Not to Reduce Excess Reserves by David C. Wheelock in Federal Reserve Bank of St. Louis Economic Synopses , August 2009

The author looks back to a simliar economic situation during the 1930s for insights into how to handle excess reserves.

How the Subprime Crisis Went Global: Evidence from Bank Credit Default Swap Spreads by Barry Eichengreen, Ashoka Mody, Milan Nedeljkovic, and Lucio Sarno in NBER Working Paper (requires subscription) , April 2009

How did the Subprime Crisis, a problem in a small corner of U.S. financial markets, affect the entire global banking system? To shed light on this question we use principal components analysis to identify common factors in the movement of banks' credit default swap spreads. We find that fortunes of international banks rise and fall together even...  

How to Avoid a New Financial Crisis by Oliver Hart and Luigi Zingales in University of Chicago Booth School of Business Research Paper , November 2009

This paper discusses the origins of the financial crisis in terms of risk, and then offers proposals for ways to fix the system.

International Policy Response to the Financial Crisis by Masaaki Shirakawa in Federal Reserve Bank of Kansas City Symposium , August 2009

A discussion of the future of international coordination between central banks in the wake of the current financial crisis.

Interview with Raghuram Rajan in Federal Reserve Bank of Minneapolis Region , December 2009

An interview with Rajan discussing the current financial crisis and possible solutions for the future.

Is Monetary Policy Effective During Financial Crises? by Frederic S. Mishkin in NBER Working Paper (requires subscription) , January 2009

The tightening of credit standards and the failure of the cost of credit to households and businesses to fall despite the sharp easing of monetary policy has led to a common view that monetary policy has not been effective during the recent financial crisis. Mishkin disagrees and believes that financial crises of the type we have been experiencing ...  

Is the Financial Crisis Over? A Yield Spread Perspective by Massimo Guidolin and Yu Man Tam in Federal Reserve Bank of St. Louis Economic Synopses , September 2009

Our finding is consistent with some recent, substantial volatility in the U.S. corporate bond market and leaves open a possibility that additional, future shocks to default premia may have long-lived effects.

Lessons Learned? Comparing the Federal Reserve’s Responses to the Crises of 1929-1933 and 2007-2009 by David C. Wheelock in Federal Reserve Bank of St. Louis Review , March 2010

The financial crisis of 2007-09 is widely viewed as the worst financial disruption since the Great Depression of 1929-33. However, the accompanying economic recession was mild compared with the Great Depression, though severe by postwar standards. Aggressive monetary, fiscal, and financial policies are widely credited with limiting the impact of...  

Lessons of the Crisis: The Implications for Regulatory Reform by William C. Dudley in Speech, Federal Reserve Bank of New York , January 2010

Remarks at the Partnership for New York City Discussion, New York City.

The Longer-Term Challenges Ahead by William C. Dudley in Federal Reserve Bank of New York Speech , March 2010

Remarks at the Council of Society Business Economists Annual Dinner, London, United Kingdom

Macroprudential Supervision and Monetary Policy in the Post-crisis World by Janet L. Yellen in Board of Governors Speech , October 2010

Speech at the Annual Meeting of the National Association for Business Economics, Denver, Colorado

The Mechanics of a Graceful Exit: Interest on Reserves and Segmentation in the Federal Funds Market by Morten L. Bech and Elizabeth Klee in Federal Reserve Bank of New York Staff Reports , December 2009

To combat the financial crisis that intensified in the fall of 2008, the Federal Reserve injected a substantial amount of liquidity into the banking system. The resulting increase in reserve balances exerted downward price pressure in the federal funds market, and the effective federal funds rate began to deviate from the target rate set by the Fed...  

Monetary Policy and Asset Prices by Brett W. Fawley and Luciana Juvenal in Federal Reserve Bank of St. Louis Economic Synopses , April 2010

reminder that asset prices can and do run wild at rates capable of negative effects on real economic activity. Not surprisingly, this has reinvigorated debate over whether central banks should respond to asset price bubbles.

Monetary Policy and the Recent Extraordinary Measures Taken by the Federal Reserve by John B. Taylor in U.S. House Committee on Financial Services , February 2009

Written testimony before the Committee on Financial Services U.S. House of Representatives on monetary policy and the "extraordinary measures" taken by the Federal Reserve over the past 18 months.

Monetary Policy in the Crisis: Past, Present, and Future by Donald L. Kohn in Board of Governors Speech , January 2010

Speech given at the Brimmer Policy Forum, American Economic Association Annual Meeting, Atlanta, Georgia

More Lessons from the Crisis by William C. Dudley in Federal Reserve Bank of New York Speech , November 2009

Remarks at the Center for Economic Policy Studies Symposium

More Money: Understanding Recent Changes in the Monetary Base by William T. Gavin in Federal Reserve Bank of St. Louis Review , March 2009

The financial crisis that began in the summer of 2007 took a turn for the worse in September 2008. Until then, Federal Reserve actions taken to improve the functioning financial markets did not affect the monetary base. The unusual lending and purchase of private debt was offset by the sale of Treasury securities so that the total size of the ba...  

Moving Beyond the Financial Crisis by Elizabeth A. Duke in Board of Governors Speech , June 2010

At the Consumer Bankers Association Annual Conference, Hollywood, Florida

On the Effectiveness of the Federal Reserve's New Liquidity Facilities by Tao Wu in Federal Reserve Bank of Dallas Working Paper , May 2008

This paper examines the effectiveness of the new liquidity facilities that the Federal Reserve established in response to the recent financial crisis. I develop a no-arbitrage based affine term structure model with default risk and conduct a thorough factor analysis of the counterparty default risk among major financial institutions and the underly...  

Paying Interest on Deposits at Federal Reserve Banks by Richard G. Anderson in Federal Reserve Bank of St. Louis Economic Synopses , November 2008

The implementation of monetary policy in developed economies relies on three interest rates: a policy target rate, one or more lending (or, discount) rates, and a remuneration rate, the rate of interest the central bank pays on the deposits that banks hold at the central bank. In the current economic crisis, management of the remuneration rate has ...  

Policies to Bring Us Out of the Financial Crisis and Recession by Donald L. Kohn in Speech , April 2009

Kohn discusses the actions the government is taking to address our current financial and economic difficulties, focusing on the economic and financial problems and policy responses in the United States.

Provision of Liquidity through the Primary Credit Facility during the Financial Crisis: A Structural Analysis by Erhan Artuç and Selva Demiralp in Federal Reserve Bank of New York Economic Policy Review , October 2009

In response to the liquidity crisis that began in August 2007, central banks designed a variety of tools for supplying liquidity to financial institutions. The Federal Reserve introduced several programs, such as the Term Auction Facility, the Term Securities Lending Facility, and the Primary Dealer Credit Facility, while enhancing its open market ...  

Putting the Low Road Behind Us by Governor Sarah Bloom Raskin in Speech at the 2011 Midwinter Housing Finance Conference, Park City, Utah , February 2011

In this speech Governor Raskin shares some thoughts about the powerful impact the housing and mortgage markets have on the nation's economic recovery, presents some ideas to effect positive change in the mortgage servicing industry, and finally imparts a guiding principle that should help us find our way through the current struggles and drive the ...  

Quantitative Easing: Entrance and Exit Strategies by Alan S. Blinder in Federal Reseve Bank of St. Louis Homer Jones Memorial Lecture , April 2010

Blinder discussed the concept of quantitative easing, the Fed's entrance strategy, the Fed's exit strategy, and its implications for central bank independence.

Questions about Fiscal Policy: Implications from the Financial Crisis of 2008-2009 by N. Gregory Mankiw in Federal Reserve Bank of St. Louis Review , May 2010

This article is a modified version of remarks given at the Federal Reserve Bank of Philadelphia’s policy forum “Policy Lessons from the Economic and Financial Crisis,” December 4, 2009.

Questions and Answers about the Financial Crisis by Gary Gorton in Prepared Testimony for the U.S. Financial Crisis Inquiry Commission , February 2010

All bond prices plummeted (spreads rose) during the financial crisis, not just the prices of subprimerelated bonds. These price declines were due to a banking panic in which institutional investors and firms refused to renew sale and repurchase agreements (repo) – short?term, collateralized, agreements that the Fed rightly used to count as money...  

Reaping the Full Benefits of Financial Openness by Yellen, Janet L. in Federal Reserve Board of Governors Speech , May 2011

Speech at the Bank of Finland 200th Anniversary Conference, Helsinki, Finland

Reflections on a Year of Crisis by Ben S. Bernanke in Federal Reserve Bank of Kansas City Symposium , August 2009

The opening remarks at the Jackson Hole conference, "Financial Stability and Macroeconomic Policy"

Resolution Process for Financial Companies that Pose Systemic Risk to the Financial System and Overall Economy by Thomas M. Hoenig, Charles S. Morris, and Kenneth Spong in Federal Reserve Bank of Kansas City Speech , September 2009

The Under current law, financial regulators do not have the authority to resolve financial holding companies and non-depository financial companies that are in default or serious danger of default as they have with depository institutions. Although the normal bankruptcy process is a very effective process for most non-depository financial companie...  

Rethinking Macroeconomic Policy by Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro in IMF Staff Position Note , February 2010

The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment. In this paper, we review the main elements of the pre-crisis consensus, we identify where we were wrong and what tenets of the pre-crisis framework still hold, a...  

The Risk of Deflation by John C.Williams in Federal Reserve Bank of San Francisco Economic Letter , March 2009

This article examines the risk of deflation in the United States by reviewing the evidence from past episodes of deflation and inflation.

The Role of the Federal Reserve in a New Financial Order by Paul A. Volcker in Speech at the Economic Club of New York , January 2010

Paul Volcker's discussion of the role of the Federal Reserve in light of the Financial Crisis.

The Role of the Securitization Process in the Expansion of Subprime Credit by Taylor D. Nadauld and Shane M. Sherlund in Board of Governors Finance and Economics Discussion Series , April 2009

The authors analyze the structure and attributes of subprime mortgage-backed securitization deals originated between 1997 and 2007. Their data set allows us to link loan-level data for over 6.7 million subprime loans to the securitization deals into which the loans were sold. They show that the securitization process, including the assignment of cr...  

Shadow Banking by Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, Hayley Boesky in Federal Reserve Bank of New York Staff Reports no. 458 , July 2010

This paper documents the origins, evolution and economic role of the shadow banking system. Its aim is to aid regulators and policymakers globally to reform, regulate and supervise the process of securitized credit intermediation in a market-based financial system.

The Shadow Banking System: Implications for Financial Regulation by Tobias Adrian and Hyun Song Shin in Federal Reserve Bank of New York Staff Report , July 2009

The current financial crisis has highlighted the growing importance of the “shadow banking system,” which grew out of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States, but it has had a profound influence on the global financial system. In a market-...  

Should Monetary Policy “Lean or Clean”?* by William R. White in Federal Reserve Bank of Dallas Working Paper , August 2009

It has been contended by many in the central banking community that monetary policy would not be effective in “leaning” against the upswing of a credit cycle (the boom) but that lower interest rates would be effective in “cleaning” up (the bust) afterwards. In this paper, these two propositions (can’t lean, but can clean) are examined and found ser...  

Some Observations and Lessons from the Crisis by Simon M. Potter in Federal Reserve Bank of New York Speech , June 2010

Remarks at the Third Annual Connecticut Bank and Trust Company Economic Outlook Breakfast, Hartford, Connecticut

Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’ by James Crotty in University of Massachusetts Amherst Working Paper , August 2008

The main thesis of this paper is that the ultimate cause of the current global financial crisis is to be found in the deeply flawed institutions and practices of what is often referred to as the New Financial Architecture (NFA) – a globally integrated system of giant bank conglomerates and the so-called ‘shadow banking system’ of investment ban...  

Systemic Risk and Deposit Insurance Premiums by Viral V. Acharya, João A. C. Santos, and Tanju Yorulmazer in Federal Reserve Bank of New York Economic Policy Review , October 2009

While systemic risk—the risk of wholesale failure of banks and other financial institutions—is generally considered to be the primary reason for supervision and regulation of the banking industry, almost all regulatory rules treat such risk in isolation. In particular, they do not account for the very features that create systemic risk in the first...  

Systemic Risk and the Financial Crisis: A Primer by James Bullard, Christopher J. Neely, and David C. Wheelock in Federal Reserve Bank of St. Louis Review , September 2009

How did problems in a relatively small portion of the home mortgage market trigger the most severe financial crisis in the United States since the Great Depression? Several developments played a role, including the proliferation of complex mortgage-backed securities and derivatives with highly opaque structures, high leverage, and inadequate risk m...  

The Term Securities Lending Facility: Origin, Design, and Effects by Michael J. Fleming, Warren B. Hrung and Frank M. Keane in Federal Reserve Bank of New York Current Issues in Economics and Finance , February 2009

The Federal Reserve launched the Term Securities Lending Facility (TSLF) in 2008 to promote liquidity in the funding markets and improve the operation of the broader financial markets. The facility increases the ability of dealers to obtain cash in the private market by enabling them to pledge securities temporarily as collateral for Treasuries, wh...  

Three Funerals and a Wedding by James B. Bullard in Federal Reserve Bank of St. Louis Review , January 2009

A discussion of three macroeconomic ideas that may be passing away, and one macroeconomic idea that is being rehabilitated.

Three Lessons for Monetary Policy from the Panic of 2008 by James Bullard in Federal Reserve Bank of St. Louis Review , May 2010

This article is a modified version of a presentation given at the Federal Reserve Bank of Philadelphia’s policy forum “Policy Lessons from the Economic and Financial Crisis,” December 4, 2009.

The U.S. Financial System: Where We Have Been, Where We Are and Where We Need to Go by William C. Dudley in Federal Reserve Bank of New York Speech , February 2010

Remarks at the Reserve Bank of Australia's 50th Anniversary Symposium, Sydney, Australia

Unconventional Monetary Policy Actions by Glen D. Rudebusch in Federal Reserve Bank of San Francisco FedViews , March 2009

Glenn D. Rudebusch, senior vice president and associate director of research at the Federal Reserve Bank of San Francisco, states his views on recent unconventional monetary policy actions. Charts are included.

United States: Financial System Stability Assessment by The Monetary and Capital Markets and Western Hemisphere Departments of the International Monetary Fund in International Monetary Fund, IMF Country Report No. 10/247 , July 2010

A forceful policy response has rolled back systemic market pressures, but the cost of intervention has been high and stability is tenuous. Comprehensive reforms are being legislated, addressing many of the issues that left the system vulnerable. Given the severity of the crisis and the many weaknesses revealed, bolder action could have been envi...  

Valuing the Treasury’s Capital Assistance Program by Paul Glasserman and Zhenyu Wang in Federal Reserve Bank of New York Staff Reports , December 2009

The Capital Assistance Program (CAP) was created by the U.S. government in February 2009 to provide backup capital to large financial institutions unable to raise sufficient capital from private investors. Under the terms of the CAP, a participating bank receives contingent capital by issuing preferred shares to the Treasury combined with embedded ...  

A View of the Economic Crisis and the Federal Reserve’s by Janet L. Yellen in Federal Reserve Bank of San Francisco Economic Letter , July 2009

The Federal Reserve has responded to a severe recession by developing programs to bolster the financial system and restore economic growth. The Fed has the tools to unwind these programs when appropriate, maintaining price stability. The following is adapted from a speech delivered by the president and CEO of the Federal Reserve Bank of San Francis...  

Walter Bagehot, the Discount Window, and TAF by Daniel Thornton in Federal Reserve Bank of St. Louis Economic Synopses , October 2008

In response to the mortgage-related distress in financial markets, the Fed has implemented a number of new lending programs. Prominent among these is the Term Auction Facility (TAF), through which the Federal Reserve Banks auction funds to depository institutions. Under the TAF, depository institutions compete for funds by indicating the amount th...  

Would Quantitative Easing Sooner Have Tempered the Financial Crisis and Economic Recession? by Daniel L. Thornton in Federal Reserve Bank of St. Louis Economic Synopses , August 2009

The author examines the timing of the quantitative easing employed by the Federal Reserve.

The Aftermath of Financial Crises by Carmen Reinhart and Kenneth S. Rogoff in Harvard University Working Paper , December 2008

This paper presents a comparative historical analysis that is focused on the aftermath of systemic banking crises. This study of the aftermath of severe financial crises includes a number of recent emerging market cases to expand the relevant set of comparators. Also included in the comparisons are two prewar developed country episodes for which w...  

Banking Crises: An Equal Opportunity Menace by Carmen M. Reinhart and Kenneth S. Rogoff in Harvard University Working Paper , December 2008

The historical frequency of banking crises is quite similar in high- and middle-to-low income countries, with quantitative and qualitative parallels in both the run-ups and the aftermath. The authors establish these regularities using a unique dataset spanning from Denmark’s financial panic during the Napoleonic War to the ongoing global financial ...  

The Crisis through the Lens of History by Charles Collyns in International Monetary Fund: Finance and Development , December 2008

The current financial crisis is ferocious, but history shows the way to avoid another Great Depression

The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century? by Gonzalo Fernández de Córdoba and Timothy J. Kehoe in Federal Reserve Bank of Minneapolis Staff Report , March 2009

Studying the experience of countries that have experienced great depressions during the twentieth century teaches us that massive public interventions in the economy to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a great depression.

The Evolution of the Subprime Mortgage Market by Souphala Chomsisengphet and Anthony Pennington-Cross in Federal Reserve Bank of St. Louis Review , January 2006

This paper describes subprime lending in the mortgage market and how it has evolved through time. Subprime lending has introduced a substantial amount of risk-based pricing into the mortgage market by creating a myriad of prices and product choices largely determined by borrower credit history (mortgage and rental payments, foreclosures and bankru...  

Financial Statistics for the United States and the Crisis: What Did They Get Right, What Did They Miss, and How Should They Change? by Matthew J. Eichner, Donald L. Kohn, and Michael G. Palumbo in Board of Governors Finance and Economics Discussion Series , April 2010

Although the instruments and transactions most closely associated with the financial crisis of 2008 and 2009 were novel, the underlying themes that played out in the crisis were familiar from previous episodes: Competitive dynamics resulted in excessive leverage and risktaking by large, interconnected firms, in heavy reliance on short-term sourc...  

The Global Credit Crisis as History by Barry Eichengreen in University of California Berkeley Polcy Paper , December 2008

During the Great Depression the Fed waited too long to execute its responsibilities as a lender of last resort, thus allowing the banking system to collapse. This time, there has been little hesitation on the part of the Fed to act, which leaves two questions: Why, given that this is a global credit crisis, have policy makers in other countries fai...  

An Historical Perspective on the Crisis of 2007-2008 by Michael D. Bordo in Bank of Chile Conference , November 2008

The current international financial crisis is part of a perennial pattern. Today’s events have echoes in earlier big international financial crises which were triggered by events in the U.S. financial system. Examples include the crises of 1857,1893, 1907 and 1929-1933. This crisis has many similarities to those of the past but also some important ...  

Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007 by Gary B. Gorton in SSRN Paper , May 2009

The 'shadow banking system' at the heart of the current credit crisis is, in fact, a real banking system – and is vulnerable to a banking panic. Indeed, the events starting in August 2007 are a banking panic. A banking panic is a systemic event because the banking system cannot honor its obligations and is insolvent. Unlike the historical banking p...  

Stock-Market Crashes and Depressions by Robert J. Barro and José F. Ursúa in NBER Working Paper (requires subscription) , February 2009

Long-term data for 25 countries up to 2006 reveal 195 stock-market crashes (multi-year real returns of -25% or less) and 84 depressions (multi-year macroeconomic declines of 10% or more), with 58 of the cases matched by timing. The United States has two of the matched events--the Great Depression 1929-33 and the post-WWI years 1917-21, likely drive...  

Systemic Banking Crisis: A New Database by Luc Laeven and Fabian Valencia in IMF Working Paper , November 2008

This paper presents a new database on the timing of systemic banking crises and policy responses to resolve them. The database covers the universe of systemic banking crises for the period 1970-2007, with detailed data on crisis containment and resolution policies for 42 crisis episodes, and also includes data on the timing of currency crises and s...  

This Time is Different: A Panoramic View of Eight Centuries of Financial Crises by Carmen M. Reinhart and Kenneth S. Rogoff in Harvard University Working Paper , April 2008

This paper offers a “panoramic” analysis of the history of financial crises dating from England’s fourteenth-century default to the current United States sub-prime financial crisis. Our study is based on a new dataset that spans all regions. It incorporates a number of important credit episodes seldom covered in the literature, including for exampl...  

Using Monetary Policy to Stabilize Economic Activity by Carl E. Walsh in Federal Reserve Bank of Kansas City Symposium , August 2009

This essay examines the role of monetary policy in stabilizing real economic activity. The author discusses the consensus on monetary policy that developed over the last twenty years. He then examines monetary policy when the policy interest rate has fallen to zero. The paper also assess issues relevant for post-crisis monetary policy.

Where We Go from Here: The Crisis and Beyond by Richard W. Fisher in Federal Reserve Bank of Dallas Speech , March 2010

Remarks before the Eller College of Management, University of Arizona

Booms and Busts: The Case of Subprime Mortgages by Edward M. Gramlich in Federal Reserve Bank of Kansas City Economic Review , September 2007

Booms and busts have played a prominent role in American economic history. In the 19th century, the United States benefited from the canal boom, the railroad boom, the minerals boom, and a financial boom. The 20th century brought another financial boom, a postwar boom, and a dot-com boom. The details differed, but each of these cases featured init...  

Central Bank Tools and Liquidity Shortages by Stephen G. Cecchetti and Piti Disyatat in Federarl Reserve Bank of New York Economic Policy Review , October 2009

The global financial crisis that began in mid-2007 has renewed concerns about financial instability and focused attention on the fundamental role of central banks in preventing and managing systemic crises. In response to the turmoil, central banks have made extensive use of both new and existing tools for supplying central bank money to financial ...  

Changes in the U.S. Financial System and the Subprime Crisis by Jan Kregel in Levy Economics Institute Working Paper , April 2008

The paper provides a background to the forces that have produced the present system of residential housing finance, the reasons for the current crisis in mortgage financing, and the impact of the crisis on the overall financial system.

The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis by Atif R. Mian, Amir Sufi in SSRN Working Paper , December 2008

We conduct a within-county analysis using detailed zip code level data to document new findings regarding the origins of the biggest financial crisis since the Great Depression. The recent sharp increase in mortgage defaults is significantly amplified in subprime zip codes, or zip codes with a disproportionately large share of subprime borrowers as...  

Counterparty Risk in the Over-The-Counter Derivatives Market by Miguel A. Segoviano and Manmohan Singh in IMF Working Paper , November 2008

The financial market turmoil of recent months has highlighted the importance of counterparty risk. Here, we discuss counterparty risk that may stem from the OTC derivatives markets and attempt to assess the scope of potential cascade effects. This risk is measured by losses to the financial system that may result via the OTC derivative contracts fr...  

The Credit Crisis and Cycle Proof Regulation by Raghuram G. Rajan in Federal Reserve Bank of St. Louis Review , September 2009

Rajan offers what he called "cycle proof regulation" to help head off a future crisis. Among other things, he proposed: -Highly leveraged financial institutions would be required to buy fully collateralized insurance. This insurance would inject contingent capital into those institutions when they're in trouble. -Financial institutions considered...  

The Credit Crisis: Conjectures about Causes and Remedies by Douglas W. Diamond and Raghuram G. Rajan in AEA Presentation Paper , December 2008

What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite answers to these questions, the focus of this paper is to offer offer informed conjectures.

Did Credit Scores Predict the Subprime Crisis? by Yuliya Demyanyk in Federal Reserve Bank of St. Louis Regional Economist , October 2008

One might expect to find a connection between borrowers' FICO scores and the incidence of default and foreclosure during the current crisis. The data don't show such a cause and effect, however.

Did Prepayments Sustain the Subprime Market? by Geetesh Bhardwaj and Rajdeep Sengupta in Federal Reserve Bank of St. Louis Working Paper , October 2008

This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial ...  

The Fed's Expanded Balance Sheet by Brian P. Sack in Federal Reserve Bank of New York Speech , December 2009

The Fed’s balance sheet has moved to the forefront of its policy efforts. Accordingly, to understand the policy choices that lie ahead for the Federal Reserve, one has to understand how the balance sheet got to where it is and what effects it has had on financial markets.

Financial Crises and Economic Activity by Stephen G. Cecchetti, Marion Kohler and Christian Upper in Federal Reserve Bank of Kansas City Symposium , August 2009

The authors use historical data to examine past systemic banking crises and compare them to the current crisis. They also look at the long-term effects of a crisis on economic output.

The Financial Crisis and the Policy Response: An Empirical Analysis of What Went Wrong by John B. Taylor in Stanford University Working Paper , November 2008

This paper is an empirical investigation of the role of government actions and interventions in the financial crisis that flared up in August 2007.

Financial Reform or Financial Dementia? by Richard W. Fisher in Federal Reserve Bank of Dallas Speech , June 2010

Remarks at the SW Graduate School of Banking 53rd Annual Keynote Address and Banquet

Fixing Finance: A Roadmap for Reform by Robert E. Litan and Martin N. Baily in Brookings Institution , February 2009

This paper suggests a roadmap for reform of the financial system. The authors suggest that the guiding principles should be market discipline and sound regulation, and provide a detailed outline for changes in financial policy.

Has Financial Development Made the World Riskier? by Raghuram G. Rajan in Federal Reserve Bank of Kansas City's Symposium: The Greenspan Era: Lessons for the Future , August 2005

This paper (written pre-crisis in 2005) examines the revolutionary changes in financial systems around the world, such as greater borrowing at lower rates, the multitude of investment options catering to every possible profile of risk and return, and the ability to share risks with strangers from across the globe. The author questions the costs of...  

Has the Recent Real Estate Bubble Biased the Output Gap? by Chanont Banternghansa and Adrian Peralta-Alva in Federal Reserve Bank of St. Louis Economic Synopses , December 2009

The authors offer a word of caution to policymakers: Policies based on point estimates of the output gap may not rest on solid ground.

Hedge Funds, Systemic Risk, and the Financial Crisis of 2007-2008 by Andrew W. Lo in U.S. House Committee on Oversight and Government Reform , November 2008

This article is the written testimony of Andrew Lo on the role of hedge funds in the U.S. financial system and their regulation. For the preliminary transcript, see http://oversight.house.gov/documents/20081114143312.pdf

The Information Value of the Stress Test and Bank Opacity by Stavros Peristiani, Donald P. Morgan, and Vanessa Savino in Federal Reserve Bank of New York Staff Reports, no. 460 , July 2010

We investigate whether the “stress test,” the extraordinary examination of the nineteen largest U.S. bank holding companies conducted by federal bank supervisors in 2009, produced information demanded by the market. Using standard event study techniques, we find that the market had largely deciphered on its own which banks would have capital ga...  

Lessons for the Future from the Financial Crisis by Eric S. Rosengren in Speech before Massachusetts Newspaper Publishers Association Annual Meeting , December 2009

In a storytelling format, Rosengren explains why it was necessary to “bail out” certain firms – like AIG – and what this story teaches us about avoiding such necessities in the future. Also, why the Federal Reserve took such aggressive action to dramatically expand its balance sheet to address the crisis – and what implications and effects we expe...  

Making Sense of the Subprime Crisis by Kristopher S. Gerardi, Andreas Lehnert, Shane M. Sherland, and Paul S. Willen in Federal Reserve Bank of Boston Working Paper , December 2008

This paper explores the question of whether market participants could have or should have anticipated the large increase in foreclosures that occurred in 2007 and 2008. Most of these foreclosures stem from loans originated in 2005 and 2006, leading many to suspect that lenders originated a large volume of extremely risky loans during this period. ...  

Monetary Policy and the Housing Bubble by Ben S. Bernanke in Board of Governors Speech , January 2010

Speech given at the Annual Meeting of the American Economic Association, Atlanta, Georgia

Quick Exits of Subprime Mortgages by Yuliya S. Demyanyk in Federal Reserve Bank of St. Louis Review , March 2009

All holders of mortgage contracts, regardless of type, have three options: keep their payments current, prepay (usually through refinancing), or default on the loan. The latter two options terminate the loan. The termination rates of subprime mortgages that originated each year from 2001 through 2006 are surprisingly similar: about 20, 50, and 8...  

Regulation and Its Discontents by Kevin Warsh in Board of Governors Speech , February 2010

At the New York Association for Business Economics, New York, New York

Rethinking Capital Regulation by Anil K. Kashyap, Raghuram G. Rajan and Jeremy C. Stein in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System , September 2008

Recent estimates suggest that U.S. banks and investment banks may lose up to $250 billion from their exposure to residential mortgages securities. The resulting depletion of capital has led to unprecedented disruptions in the market for interbank funds and to sharp contractions in credit supply, with adverse consequences for the larger economy. A n...  

The Rise in Mortgage Defaults by Chris Mayer, Karen Pence and Shane M. Sherlund in Federal Reserve Board Finance and Economics Discussion Series , November 2008

The main factors underlying the rise in mortgage defaults appear to be declines in house prices and deteriorated underwriting standards, in particular an increase in loan-to-value ratios and in the share of mortgages with little or no documentation of income.

The Subprime Crisis: Cause, Effect and Consequences by R. Christopher Whalen in SSRN Working Paper , June 2008

Despite the considerable media attention given to the collapse of the market for complex structured assets that contain subprime mortgages, there has been too little discussion of why this crisis occurred. The Subprime Crisis: Cause, Effect and Consequences argues that three basic issues are at the root of the problem, the first of which is an odio...  

Subprime Facts: What (We Think) We Know about the Subprime Crisis and What We Don't by Christopher L. Foote, Kristopher Gerardi, Lorenz Goette and Paul S. Willen in Federal Reserve Bank of Boston Public Policy Discussion Paper , May 2008

Using a variety of datasets, the authors document some basic facts about the current subprime crisis. Many of these facts are applicable to the crisis at a national level, while some illustrate problems relevant only to Massachusetts and New England. The authors conclude by discussing some outstanding questions about which the data, which they beli...  

Subprime Lending and Real Estate Markets by Susan M. Wachter, Andrey D. Pavlov, and Zoltan Pozsar in SSRN Working Paper , December 2008

The recent credit crunch, and liquidity deterioration, in the mortgage market have led to falling house prices and foreclosure levels unprecedented since the Great Depression. A critical factor in the post-2003 house price bubble was the interaction of financial engineering and the deteriorating lending standards in real estate markets, which fed o...  

Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures by Kristopher Gerardi, Adam Hale Shapiro and Paul S. Willen in Federal Reserve Bank of Boston Working Paper , May 2008

This paper provides the first rigorous assessment of the homeownership experiences of subprime borrowers. We consider homeowners who used subprime mortgages to buy their homes, and estimate how often these borrowers end up in foreclosure. In order to evaluate these issues, we analyze homeownership experiences in Massachusetts over the 1989–2007 per...  

The Subprime Turmoil: What's Old, What's New, and What's Next by Charles W. Calomiris in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System" , October 2008

We are currently experiencing a major shock to the financial system, initiated by problems in the subprime market, which spread to securitization products and credit markets more generally. Banks are being asked to increase the amount of risk that they absorb (by moving off-balance sheet assets onto their balance sheets), but losses that the banks...  

U.S. Monetary Policy and the Financial Crisis by James R. Lothian in Federal Reserve Bank of Atlanta CenFIS Working Paper , December 2009

This paper reviews U.S. Federal Reserve policy prior to and during the course of the recession that began in December 2007. It compares those policies to monetary policy during the Great Depression of the 1930s, with which this recession has been likened. The paper then discusses what policymakers will need to do to in future to avoid a surge in in...  

Understanding the Securitization of Subprime Mortgage Credit by Adam B. Ashcraft and Til Schuermann in Federal Reserve Bank of New York Staff Reports , March 2008

In this paper, the authors provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. They discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. They continue with a complete picture of the subprime borrower and the subp...  

Understanding the Subprime Mortgage Crisis by Yuliya Demyanyk and Otto Van Hemert in SSRN Working Paper , December 2008

In this paper the authors provide evidence that the rise and fall of the subprime mortgage market follows a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. Problems could have been detected long before the crisis, but they were masked by high house price appreciation between 2003 and 2005.

What to Do about Systemically Important Financial Institutions by James B. Thomson in Federal Reserve Bank of Cleveland , August 2009

The Federal Reserve Bank of Cleveland is proposing a three-tiered system for regulating systemically important financial institutions. Tier one would include high-risk institutions, such as large, interstate banks and multi-state insurance companies. Tier two would include moderately complex financial institutions, such as larger regional banks. An...  

Where's the Smoking Gun? A Study of Underwriting Standards for US Subprime Mortgages by Geetesh Bhardwaj and Rajdeep Sengupta in Federal Reserve Bank of St. Louis Working Paper , October 2008

The dominant explanation for the meltdown in the US subprime mortgage market is that lending standards dramatically weakened after 2004. Using loan-level data, Bhardwaj and Sengupta examine underwriting standards on the subprime mortgage originations from 1998 to 2007. Contrary to popular belief, the authors find no evidence of a dramatic weakening...  

Have the Fed Liquidity Facilities Had an Effect on Libor? by Jens Christensen in Federal Reserve Bank of San Francisco Economic Letter , August 2009

In response to turmoil in the interbank lending market, the Federal Reserve inaugurated programs to bolster liquidity beginning in December 2007. Research offers evidence that these liquidity facilities have helped lower the London interbank offered rate, a key market benchmark, significantly from what it otherwise would have been expected to be.

Macroprudential Supervision of Financial Institutions: Lessons from the SCAP by Beverly Hirtle, Til Schuermann, and Kevin Stiroh in Federal Reserve Bank of New York Staff Reports , November 2009

A fundamental conclusion drawn from the recent financial crisis is that the supervision and regulation of financial firms in isolation—a purely microprudential perspective—are not sufficient to maintain financial stability. Rather, a macroprudential perspective, which evaluates and responds to the financial system as a whole, seems necessary, and t...  

Paulson’s Gift by Pietro Veronesi and Luigi Zingales in NBER Working Paper , October 2009

The authors calculate the costs and benefits of the largest ever U.S. Government intervention in the financial sector announced the 2008 Columbus-day weekend. They estimate that this intervention increased the value of banks’ financial claims by $131 billion at a taxpayers’ cost of $25 -$47 billions with a net benefit between $84bn and $107bn. B...  

Quantitative Easing—Uncharted Waters for Monetary Policy by James Bullard in Federal Reserve Bank of St. Louis Regional Economist , January 2010

A discussion of the use of quantiative easing in monetary policy

What the Libor-OIS Spread Says by Daniel L. Thornton in Federal Reserve Bank of St. Louis Economic Synopses , May 2009

This paper offers a discussion of the current Libor-OIS rate spread, and what that rate implies for the health of banks.

Possible Solutions / Next Steps

Addressing TBTF by Shrinking Financial Institutions: An Initial Assessment by Gary H. Stern and Ron Feldman in Federal Reserve Bank of Minneapolis , May 2009

In this essay, the authors review concerns about the "make-them-smaller" reform. They recommend several interim steps to address TBTF that share some similarities with the make-them-smaller approach but do not have the same failings. Specifically, they support (1) imposing special deposit insurance assessments for TBTF banks to allow for spillover-...  

Aiding the Economy: What the Fed Did and Why by Ben S. Bernanke in Board of Governors , November 2010

Federal Reserve Chairman Bernanke's Op-ed column published in The Washington Post on November 4, 2010

Are All the Sacred Cows Dead? Implications of the Financial Crisis for Macro and Financial Policies by Asli Demirgüç-Kunt and Luis Servén in World Bank Policy Research Working Paper , January 2009

The recent global financial crisis has shaken the confidence of developed and developing countries alike in the very blueprint of financial and macro policies that underlie the western capitalist systems. In an effort to contain the crisis from spreading, the authorities in the US and many European governments have taken unprecedented steps of prov...  

As In the Past, Reform Will Follow Crisis by James Bullard in Federal Reserve Bank of St. Louis Regional Economist , July 2009

Historically, crises have led to significant legislation. The current financial crisis will undoubtedly spur further regulation. Successful regulation should be aimed not at preventing all failures, but rather at establishing a clear and credible process such that if a failure were to occur, it would take place in an orderly fashion and not cause i...  

Asset Bubbles and Systemic Risk by Eric S. Rosengren in Federal Reserve Bank of Boston Speech , March 2010

The Global Interdependence Center's Conference on "Financial Interdependence in the World's Post-Crisis Capital Markets" Philadelphia, Pennsylvania

Bank Capital: Lessons from the Financial Crisis by Asli Demirguc-Kunt, Enrica Detragiache, Ouarda Merrouche in World Bank Policy Research Working Paper, WPS5473 , November 2010

Using a multi-country panel of banks, the authors study whether better capitalized banks fared better in terms of stock returns during the financial crisis.

Bank Relationships and the Depth of the Current Economic Crisis by Julian Caballero, Christopher Candelaria, and Galina Hale in Federal Reserve Bank of San Francisco Economic Letter , December 2009

The financial crisis has been worldwide in scope, but the severity has differed from country to country. Those countries whose banks played a more central role in the global financial system, were important intermediaries, or had extensive direct relationships tended to be less seriously affected, as measured by the extent of the decline in their s...  

Buying Troubled Assets by Lucian A. Bebchuk in Harvard Law and Economics Discussion Paper (via SSRN) , April 2009

This paper analyzes how government intervention in the market for banks’ troubled assets is best designed, and also uses this analysis to evaluate the public-private investment program announced by the U.S. government in March 2009. The author begins by presenting the case for using government funds to restart the market for troubled assets. He the...  

Can Monetary Policy Affect GDP Growth? by Yi Wen in Federal Reserve Bank of St. Louis Economic Synopses , April 2009

Discusses whether the growth of the monetary base is associated with gaster growth of real output.

Challenges for monetary policy in EMU by Axel Weber in Homer Jones Memorial Lecture , April 2011

Bundesbank President discussed the financial crisis and its lessons for monetary policy in a lecture at the St. Louis Fed.

The Changing Nature of Financial Intermediation and the Financial Crisis of 2007-09 by Tobias Adrian and Hyun Song Shin in Federal Reserve Bank of New York Staff Reports , March 2010

The financial crisis of 2007-09 highlighted the changing role of financial institutions and the growing importance of the “shadow banking system,” which grew out of the securitization of assets and the integration of banking with capital market developments. This trend was most pronounced in the United States, but it also had a profound influence o...  

The Consolidation of Financial Market Regulation: Pros, Cons, and Implications for the United States by Sabrina R. Pellerin, John R. Walter, and Patricia E. Wescott in Federal Reserve Bank of Richmond Working Paper , May 2009

The U.S. financial system has changed significantly over the last several decades without any major structural changes to the decentralized financial regulatory system, despite numerous proposals. In the past decade, many countries have chosen to consolidate their regulators into a newly formed "single regulator" or have significantly reduced the n...  

Cracks in the System: Repairing the Damaged Global Economy by Olivier Blanchard in International Monetary Fund: Finance and Development , December 2008

The financial crisis has exposed weaknesses in the current regulatory and supervisory frameworks, which have made clear that action is needed to reduce the risk of crises and to address them when they occur.

Credible Alertness Revisited by Jean-Claude Trichet in Federal Reserve Bank of Kansas City Symposium , August 2009

A discussion of three issues facing central banks: the relationship between asset prices and monetary policy; the effectiveness of the standard interest rate instrument; and the design of non-standar monetary policy measures such as the ECB's enhanced credit support.

Credit Derivatives: Systemic Risks and Policy Options by John Kiff, Jennifer Elliott, Elias Kazarian, Jodi Scarlata, and Carolyne Spackman in IMF Working Paper , November 2009

Credit derivative markets are largely unregulated, but calls are increasingly being made for changes to this “hands off” stance, amidst concerns that they helped to fuel the current financial crisis, or that they could be a cause of the next one. The purpose of this paper is to address two basic questions: (i) do credit derivative markets increase ...  

The Crisis by Alan Greenspan in Brookings Papers on Economic Activity , April 2010

To prevent a future financial crisis, the primary imperative must be increased regulatory capital and liquidity requirements on banks and significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades, Greenspan says. He offers his views about regulatory reform,...  

Emerging from the Crisis: Where Do We Stand? by Ben S. Bernanke in Board of Governors Speech , November 2010

Speech by Federal Reserve Chairman at the Sixth European Central Bank Central Banking Conference, Frankfurt, Germany

The Fed at a Crossroads by James Bullard in Federal Reserve Bank of St. Louis Speech , March 2010

Remarks at St. Cloud State University's 48th annual Winter Institute

Fed Confronts Financial Crisis by Expanding Its Role as Lender of Last Resort by John V. Duca, Danielle DiMartino and Jessica J. Renier in Federal Reserve Bank of Dallas Economic Letter , February 2009

The unprecedented actions the Fed has taken to combat the financial crisis have had some success in unclogging the economy's financial arteries, according to this article.

Federal Reserve Liquidity Programs: An Update by Niel Willardson and LuAnne Pederson in The Region (Federal Reserve Bank of Minneapolis) , June 2010

A review of the size, status and results of the Fed's programs to cope with crisis

The Federal Reserve's Asset Purchase Program by Janet Yellen in Speech at the The Brimmer Policy Forum, Allied Social Science Associations Annual Meeting, Denver, Colorado , January 2011

Yellen discusses the rationale for the decision by the Federal Open Market Committee (FOMC) in November 2010 to initiate a new program of asset purchases, and addresses questions (FAQs) regarding the program's economic and financial effects both in the U.S. and abroad.

The Federal Reserve's Liquidity Facilities by William C. Dudley in Speech , April 2009

Remarks at the Vanderbilt University Conference on Financial Markets and Financial Policy Honoring Dewey Daane, Nashville, Tennessee

The Federal Reserve's Policy Actions during the Financial Crisis and Lessons for the Future by Donald L. Kohn in Board of Governors Speech , May 2010

Speech at the Carleton University, Ottawa, Canada

The Financial Crisis and the Recession: What is Happening and What the Government Should Do by Robert E. Hall and Susan E. Woodward

Woodward and Hall frequently update a document on the crisis and recession. The highlights of the document are: Low interest rates in the early part of the decade were responsible monetary policy to head off deflation, not an irresponsible contribution to a housing price bubble. The most important fact about the economy today is the collapse of s...  

The Financial Crisis of 2008: What Needs to Happen after TARP by Campbell R. Harvey in Duke University Working Paper , October 2008

Harvey argues that the Trouble Asset Relief Program (TARP), signed into law on October 3, 2008, is an insufficient policy initiative to end the current credit crisis. In addition to modifications in implementing the program, other policy initiatives are necessary. Harvey sets forth several proposals to help end the crisis.

Fiscal Responsibility and Global Rebalancing by Janet L. Yellen in Federal Reserve Board of Governors , December 2010

Speech by Federal Reserve System Board of Governors Vice Chair at the Committee for Economic Development 2010 International Counterparts Conference, New York, New York .

The Future of Securities Regulation by Luigi Zingales in University of Chicago Working Paper , January 2009

The U.S. system of securities law was designed more than 70 years ago to regain investors’ trust after a major financial crisis. Today we face a similar problem. But while in the 1930s the prevailing perception was that investors had been defrauded by offerings of dubious quality securities, in the new millennium, investors’ perception is that they...  

The High Cost of Exceptionally Low Rates by Thomas M. Hoenig in Federal Reserve Bank of Kansas City , June 2010

Speech at Bartlesville Federal Reserve Forum

Implementing a Macroprudential Approach to Supervision and Regulation by Ben S. Bernanke in Federal Reserve Board of Governors Speech , May 2011

Speech at the 47th Annual Conference on Bank Structure and Competition, Chicago, Illinois

Implications of the Financial Crisis for Economics by Ben S. Bernanke in Board of Governors Speech , September 2010

Speech at the Conference Co-sponsored by the Center for Economic Policy Studies and the Bendheim Center for Finance, Princeton University, Princeton, New Jersey

Implications of the Financial Crisis for Potential Growth: Past, Present, and Future by Charles Steindel in Federal Reserve Bank of New York Staff Reports , November 2009

The scale of the recent collapse in asset values and the magnitude of the recession suggest that activities connected to the increase in values over the 2002-07 period—notably, expansion of the financial markets, homebuilding, and real estate—were overstated. If this is true, aggregate U.S. economic growth would have been overstated, implying that ...  

Improving the International Monetary and Financial System by Janet L. Yellen in Speech at the Banque de France International Symposium, Paris, France , March 2011

In this speech Yellen contributes her thoughts on steps we can take to improve our international economic order. In the case of the recent global financial crisis and recession, she apportions responsibility to inadequacies in both the monetary and financial systems.

It's Greek to Me by Kevin Warsh in Board of Governors Speech , June 2010

At the Atlanta Rotary Club, Atlanta, Georgia

The Lack of an Empirical Rationale for a Revival of Discretionary Fiscal Policy by John B. Taylor in AEA Presentation Paper , January 2009

Despite this widespread agreement of a decade ago, there has recently been a dramatic revival of interest in discretionary fiscal policy. The purpose of this paper is to review the empirical evidence during the past decade and determine whether it calls for such a revival. Taylor finds that it does not.

The macroeconomics of financial crises: How risk premiums, liquidity traps and perfect traps affect policy options by Manfred Gärtner und Florian Jung in University of St. Gallen Discussion Paper , July 2009

The paper shows that structural models of the IS-LM and Mundell-Fleming variety have a lot to tell about the macroeconomics of the current global crisis. In addition to demonstrating how the emergence of risk premiums in money and capital markets may drive economies into recessions, it shows the following: (1) Liquidity traps may occur not only whe...  

Monetary Policy Research and the Financial Crisis: Strengths and Shortcomings by Donald L. Kohn in Speech, Board of Governors , October 2009

Kohn, in his speech, asks "What aspects of the existing literature in monetary economics have been particularly helpful in formulating the course of monetary policy since the onset of the financial crisis? Second, what are the gaps in this literature that have become particularly evident since the onset of the financial crisis and, therefore, would...  

Monetary Policy Stance: The View from Consumption Spending by William T. Gavin in Federal Reserve Bank of St. Louis Economic Synopses , October 2009

The author suggests that we should expect a third business cycle in succession in which the real federal funds rate reaches its trough well after the economy begins to recover

Mortgage Choice and the Pricing of Fixed-Rate and Adjustable-Rate Mortgages by John Krainer in Federal Reserve Bank of San Francisco Economic Letter , February 2010

In the United States throughout 2009, the share of adjustable-rate mortgages among total mortgage originations was very low, apparently reflecting the attractive pricing of fixed-rate mortgages relative to ARMs. Government policy could have changed the relative attractiveness of the fixed-rate mortgages and ARMs, thereby shifting the market share o...  

Negating the Inflation Potential of the Fed’s Lending Programs by Daniel L. Thornton in Federal Reserve Bank of St. Louis Economic Synopses , July 2009

The Term Auction Facility (TAF), instituted in December 2007, was the first in a series of Fed lending facilities designed to allocate credit (and thus liquidity) to certain institutions and markets. The most recent of these lending facilities is the Term Asset-Backed Securities Loan Facility (TALF), which began operation in March 2009. Initiall...  

The New Shape of the Economic and the Financial Governance in the EU by Olli Rehn in Institute of International Finance , October 2010

Keynote Speech by EU Economic & Monetary Affairs Commissioner at The Annual Meeting Institute of International Finance

On the Record with Bernanke in PBS NewsHour Forum , July 2009

At a forum in Kansas City, Mo., Federal Reserve Chairman Ben Bernanke discussed the central bank's actions in handling the economic crisis, saying he did not want to be the Fed chief who "presided over the second Great Depression." Here is the full transcript of the forum, which was moderated by Jim Lehrer.

Paradise Lost: Addressing ‘Too Big to Fail’ (With Reference to John Milton and Irving Kristol) by Richard W. FIsher in Remarks before the Cato Institute’s 27th Annual Monetary Conference , November 2009

"In the words of Milton, I would say that regulation should be designed to enable financial institutions to be 'sufficient to have stood, though free to fall.'"

A Plan for Addressing the Financial Crisis by Lucian A. Bebchuk in Harvard Law School Working Paper , September 2008

This paper critiques the proposed emergency legislation for spending $700 billion on purchasing financial firms’ troubled assets to address the 2008 financial crisis. It also puts forward an alternative for advancing the two goals of the proposed legislation – restoring stability to the financial markets and protecting taxpayers.

Preventing Future Crises by Noel Sacasa in International Monetary Fund: Finance and Development , December 2008

This article takes a look at substantive issues in the current debates on reforming the financial sector. The first section identifies crucial weaknesses that the reforms need to address, and the second outlines key areas for policy action.

The Public Policy Case for a Role for the Federal Reserve in Bank Supervision and Regulation by Ben S. Bernanke in Board of Governors , January 2010

The Board's views on the importance of the Federal Reserve's continued role in bank supervision and regulation. The document discusses (1) how the expertise and information that the Federal Reserve develops in the making of monetary policy enable it to make a unique contribution to an effective regulatory regime, especially in the context of a more...  

Rebalancing the Global Recovery by Ben S. Bernanke in Board of Governors , November 2010

Speech by the Federal Reserve Chairman at the Sixth European Central Bank Central Banking Conference, Frankfurt, Germany

Regulating Systemic Risk by Governor Daniel K. Tarullo in Speech at the 2011 Credit Markets Symposium, Charlotte, North Carolina , March 2011

This speech addresses the implementation of the new statutory regime for special supervision and regulation of financial institutions whose stress or failure could pose a risk to financial stability.

The Regulatory Response to the Financial Crisis: An Early Assessment by Jeffrey M. Lacker in The Institute for International Economic Policy and the International Monetary Fund Institute , May 2010

Assessment of the regulatory response to this crisis will depend predominantly on how well it clarifies and places discernable boundaries around the federal financial safety net.

Remarks on "The Squam Lake Report: Fixing the Financial System" by Ben S. Bernanke in Board of Governors Speech , June 2010

At the Squam Lake Conference, New York, New York

Report on the Lessons Learned from the Financial Ccrisis with Regard to the Functioning of European Financial Market Infrastructures by European Central Bank in European Central Bank , April 2010

This report considers issues relating to the impact of the financial crisis on the functioning of European financial market infrastructures (FMIs), including systemically important payment systems, central counter parties, and securities settlement systems.

Second Chances: Subprime Mortgage Modification and Re-Default by Andrew Haughwout, Ebiere Okah, and Joseph Tracy in Federal Reserve Bank of New York Staff Reports , December 2009

Mortgage modifications have become an important component of public interventions designed to reduce foreclosures. In this paper, we examine how the structure of a mortgage modification affects the likelihood of the modified mortgage re-defaulting over the next year. Using data on subprime modifications that precede the government’s Home Affordable...  

Securitization Markets and Central Banking: An Evaluation of the Term Asset-Backed Securities Loan Facility by Sean Campbell, Daniel Covitz, William Nelson, and Karen Pence in Finance & Economic Discussion Series, #2011-16 , January 2011

This working paper studies the effects of the Term Asset-Backed Securities Loan Facility and finds that it lowered interest rate spreads for some categories of asset-backed securities but had little impact on the pricing of individual securities.

Seeking Stability: What's Next for Banking Regulation? by Simona E. Cociuba in Federal Reserve Bank of Dallas Economic Letter , April 2009

Cociuba reviews the Basel I regulatory framework, and then considers some of the improvements and shortcomings of Basel II. Cociuba then presents the example of Northern Rock to illustrate the shortcomings of Basel I, before considering what the future of bank regulation should look like.

Still More Lessons from the Crisis by William C. Dudley in Federal Reserve Bank of New York Speech , December 2009

Remarks at the Columbia University World Leaders Forum, New York, New York

The Success of the CPFF? by Richard G. Anderson in Federal Reserve Bank of St. Louis Economic Synopses , April 2009

Describes the Commercial Paper Funding Facility and its effect on the availability of commercial credit.

Uncertainty About When the Fed Will Raise Interest Rates by Michael W. McCracken in Federal Reserve Bank of St. Louis Economic Synopses , June 2009

In response to the current economic crisis, the Federal Reserve has reduced its federal funds rate (FFR) target to zero. With the FFR at zero and a negative rate practically infeasible, the Fed is now in largely uncharted territory when conducting monetary policy. Other types of policies are now the focus of attention.

What's Under the TARP? by Craig P. Aubuchon in Federal Reserve Bank of St. Louis Economic Synopses , April 2009

This article provides an outline of the TARP plan and the Financial Stability Plan.

Will Regulatory Reform Prevent Future Crises? by James Bullard in Federal Reserve Bank of St. Louis Speech , February 2010

Remarks at CFA Virginia Society, Richmond, Virginia

Will the U.S. Bank Recapitalization Succeed? Lessons from Japan by Takeo Hoshi and Anil K. Kashyap in NBER Working Paper , December 2008

The U.S. government is using a variety of tools to try to rehabilitate the U.S. banking industry. The two principal policy levers discussed so far are employing asset managers to buy toxic real estate securities and making bank equity purchases. Japan used both of these strategies to combat its banking problems. There are also a surprising number o...  

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Three Essays on Governments and Financial Crises in Developing Economies, 1870-1913

Peter H. Bent , University of Massachusetts Amherst Follow

Author ORCID Identifier

Open Access Dissertation

Document Type


Degree Name

Doctor of Philosophy (PhD)

Degree Program

Year degree awarded, month degree awarded, first advisor.

Carol E. Heim

Second Advisor

Gerald Epstein

Third Advisor

Rui Esteves

Fourth Advisor

Kevin Young

Subject Categories

This dissertation studies the factors that contribute to the onset of financial crises (Chapter 1) and the ways that economies have recovered from crises (Chapters 2 and 3). I am specifically interested in the role that governments played in financial crises and recoveries. I focus on thirty-five peripheral economies from 1870-1913. Economic historians refer to this period as the “first era of globalization” for its high degree of in- ternational capital, trade, and labor movements. This was also an economically volatile time, with relatively frequent financial crises. Other economic variables, such as com- modity prices and tariff rates, saw significant fluctuations over this period. The turn of the twentieth century offers a rich source of data for analyzing the factors that contribute to the onset of financial crises as well as the recoveries from those crises. The first chapter studies the role that capital exports from industrial Europe played in financial crises in peripheral economies from 1880-1913. Capital flows to government- supported sectors (railways, public utilities, and banks) are found to be strongly associ- ated with crises in emerging economies at this time, highlighting the role that a negative feedback loop—between governments facing financial stress and government-supported industries—played in the onset of crises. The second chapter addresses the question of what factors drive recoveries after financial crises. I find that tariff shocks had a positive impact on GDP in post-crisis periods, while terms of trade shocks had a slightly negative impact. The tariff results are especially pronounced in temperate countries, which tended to have more advanced and diversified economies. Overall this suggests that national governments, through trade policies, played a more significant role in shaping economic outcomes during this period than is typically recognized. The third chapter builds on the second chapter by focusing on the cases of the United States and Argentina in the early 1890s, when both of these countries experienced severe financial crises. Higher commodity prices played more of a role in encouraging post-crisis economic growth than did trade policy changes in these countries over this period.


Recommended Citation

Bent, Peter H., "Three Essays on Governments and Financial Crises in Developing Economies, 1870-1913" (2018). Doctoral Dissertations . 1418. https://doi.org/10.7275/7zd0-0d51 https://scholarworks.umass.edu/dissertations_2/1418

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Dissertations / Theses on the topic 'Global Financial Crisis, 2008-'

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Mykletun, Erik. "Does Regulation matter? Institutional dimension of the 2008 financial crisis." reponame:Repositório Institucional do FGV, 2010. http://hdl.handle.net/10438/7985.

Magagula, Sifiso Charles. "Liquidity linkages between the South African bond and equity markets." Thesis, Nelson Mandela Metropolitan University, 2014. http://hdl.handle.net/10948/d1020758.

Madubeko, Vongai. "The global financial crisis and its impact on the South African economy." Thesis, University of Fort Hare, 2010. http://hdl.handle.net/10353/363.

Hargaden, Kevin. "Can a Celtic tiger fit through the eye of a needle? : a theology of wealth engaging the parables of Jesus and recent Irish economic history." Thesis, University of Aberdeen, 2017. http://digitool.abdn.ac.uk:80/webclient/DeliveryManager?pid=232026.

Taszarek, Drusilla Mary Alice. "The development of the private equity industry since the 2008 financial crisis." reponame:Repositório Institucional do FGV, 2015. http://hdl.handle.net/10438/13837.

Motsi, Steve. "Competition of Sub-Saharan African banks : new empirical insights from the 2007/2008 global financial crisis." Thesis, Stellenbosch : Stellenbosch University, 2015. http://hdl.handle.net/10019.1/97472.

Phelps, Barry Keith. "Financial contagion and the transmission of the 2007 US financial crisis to South Africa." Thesis, Nelson Mandela Metropolitan University, 2012. http://hdl.handle.net/10948/d1019714.

Omar, Sabrina. "The Impact of the 2008 Global Financial Crisis on the Health of Canadians." Thesis, Université d'Ottawa / University of Ottawa, 2015. http://hdl.handle.net/10393/33372.

Tracey, Belinda. "Essays on banking in the post-crisis era." Thesis, University of Oxford, 2016. https://ora.ox.ac.uk/objects/uuid:f92fbf8c-8c20-4dcd-ad3b-a3cd89ddc538.

Kossa, Khodeu Thuo Zhagnin. "The impact of macrofinancial variables on covered interest parity violations after the 2008 global financial crisis." Master's thesis, Université Laval, 2020. http://hdl.handle.net/20.500.11794/66608.

Wan, Yue. "The Global Financial Crisis: Impacts on SMEs and Government Responses." Thèse, Université d'Ottawa / University of Ottawa, 2011. http://hdl.handle.net/10393/20078.

Sands, Daniel B. "Complexity Theory, Asymmetric Shock, and the Emergence of Previously Hidden Subsystems within the 2008/2009 Global Financial Crisis." Thesis, The University of Arizona, 2009. http://hdl.handle.net/10150/192958.

Ncube, Bhekinkosi. "Corporate governance : future perspective in light of the 2008/09 global economic meltdown." Thesis, Stellenbosch : Stellenbosch University, 2010. http://hdl.handle.net/10019.1/18183.

Salloy, Suzanne. "Empirical Essays on Contagion during the Global Financial Crisis." Thesis, Paris Est, 2013. http://www.theses.fr/2013PEST0087.

Mpala, Nqobile Natasha. "A comparative analysis of derivative regulation following the global financial crisis : an emerging markets perspective." Thesis, Rhodes University, 2015. http://hdl.handle.net/10962/d1018660.

Wilson, Jeffrey G. "The global financial crisis : a crisis of legitimacy for the hegemonic world order and the implications for South Africa." Thesis, Stellenbosch : Stellenbosch University, 2013. http://hdl.handle.net/10019.1/80159.

M'Shanga, Mayase Chituwa Simone. "Industrial policy, economic growth and unemployment in the wake of the 2008-2009 global financial crisis: The Zambian perspective." Master's thesis, University of Cape Town, 2017. http://hdl.handle.net/11427/27445.

Danielsen, Aarik J. Davis Charles N. "Examining media coverage of the subprime mouurtgage [sic] phenomenon." Diss., Columbia, Mo. : University of Missouri-Columbia, 2009. http://hdl.handle.net/10355/6724.

Ferreira, James Stuart. "An analysis of the risk adjusted returns of active versus passive South African general equity unit trusts during varying economic periods: an individual investor's perspective." Thesis, Rhodes University, 2015. http://hdl.handle.net/10962/d1019753.

Fristedt, Sebastian Carl. "Exchange-rate regimes and economic recovery : A cross-sectional study of the growth performance following the 2008 financial crisis." Thesis, Södertörns högskola, Nationalekonomi, 2017. http://urn.kb.se/resolve?urn=urn:nbn:se:sh:diva-32766.

Nguyen, Mai Lan. "Financial contagion and interactions between financial markets during global crises." Rennes 1, 2012. http://www.theses.fr/2012REN1G033.

Peabody, Stephen Drew. "Does the Method of Financing Stock Repurchases Matter? Examining the Financing of Share Buybacks and Its Effect on Future Firm Investments and Value." Thesis, University of North Texas, 2018. https://digital.library.unt.edu/ark:/67531/metadc1404597/.

Keßels, Nikolas [Verfasser]. "The Internationalization of American Market Regulation : Why an American Financial Empire Prevailed throughout the 2008 Global Financial Crisis / Nikolas Keßels." Berlin : Freie Universität Berlin, 2018. http://d-nb.info/1156603382/34.

Hamilton, Sedrick Tremayne. "Deregulation and The 2007-2008 Housing/Debt Crisis Analysis of the Housing/Debt Crisis of 2007-2008 and its impact on the Financial Strength and Vulnerability of the United States and Global Economy." reponame:Repositório Institucional do FGV, 2015. http://hdl.handle.net/10438/15061.

Ahmadu-Bello, J. "The 2007-09 global financial crisis and financial contagion effects in African stock markets." Thesis, Coventry University, 2014. http://curve.coventry.ac.uk/open/items/c9e2c0fe-dbce-4faa-abaf-945e5a282294/1.

Tjitemisa, Naftaline Meth. "The impact of the global financial crisis on the diamond supply chain : Namibia as a case study." Thesis, Stellenbosch : University of Stellenbosch, 2010. http://hdl.handle.net/10019.1/8580.

Wang, Sicong. "Gender, ethnicity and spatial autocorrelation of unemployment in Great Britain : an economic analysis." Thesis, Swansea University, 2013. http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.644356.

Butko, Sami. "Crises, Profit, and Exploitation: A Structural-Marxist Interpretation of the 2007-08 Global Financial Crisis." Thesis, Université d'Ottawa / University of Ottawa, 2018. http://hdl.handle.net/10393/38014.

Minne, Geoffrey. "The role of information in exchange rate policy and the reaction of banks during the 2007/08 crisis." Doctoral thesis, Universite Libre de Bruxelles, 2014. http://hdl.handle.net/2013/ULB-DIPOT:oai:dipot.ulb.ac.be:2013/209107.

Teixeira, Marcelo Paranaguá de Vasconcelos. "Value and momentum strategies in the Brazilian stock market: the 2008 financial crisis and its aftermath." reponame:Repositório Institucional do FGV, 2011. http://hdl.handle.net/10438/8889.

Gross, Eden. "Risk Management in South Africa Before, During, and After the 2008 Global Financial Crisis: An Application to Different Sectors." Master's thesis, Faculty of Commerce, 2021. http://hdl.handle.net/11427/32693.

Tibbetts, Evan. "Fannie Mae and Freddie Mac's march into subprime mortgages." Diss., Connect to the thesis, 2009. http://hdl.handle.net/10066/3646.

Jin, Yi. "An investigation into bank behaviour up to the 2007-08 global financial crisis." Thesis, University of Birmingham, 2013. http://etheses.bham.ac.uk//id/eprint/4126/.

Savy, Neil Edward. "Impact of the global financial crisis on economic growth: implications for South Africa and other developing economies." Thesis, Rhodes University, 2015. http://hdl.handle.net/10962/d1017542.

Otterberg, Simon, and August Zetterberg. "How much new information does a credit rating announcement convey to the financial markets? : A comparison before and after the 2008 global financial crisis." Thesis, Linnéuniversitetet, Institutionen för nationalekonomi och statistik (NS), 2020. http://urn.kb.se/resolve?urn=urn:nbn:se:lnu:diva-96878.

Abouchedid, Saulo Cabello 1987. "A política econômica no Brasil no contexto da crise financeira global (2008-2012)." [s.n.], 2014. http://repositorio.unicamp.br/jspui/handle/REPOSIP/286496.

Guittet, Stéphane J. "Reforming financial regulation after the global financial crisis : the case of over-the-counter derivative market regulation." Thesis, Paris, Institut d'études politiques, 2013. http://www.theses.fr/2013IEPP0058.

Sag, Mustafa Onur. "The Effects Of Transition To Modern Banking And 2008 Global Financial Crisis On The Efficiency Of The Turkish Banking Sector." Master's thesis, METU, 2010. http://etd.lib.metu.edu.tr/upload/12612663/index.pdf.

Tsang, Chun-ping, and 曾俊平. "Housing market bubbling again after the global financial crisis in 2008: government's actions to prevent thebursting of the housing bubble." Thesis, The University of Hong Kong (Pokfulam, Hong Kong), 2012. http://hub.hku.hk/bib/B48343353.

Hummel, Detlev. "Deutsche Kapitalbeteiligungsgesellschaften im Umfeld der globalen Finanzkrise 2008/2009." Universität Potsdam, 2011. http://opus.kobv.de/ubp/volltexte/2011/5010/.

Laing, Fredl. "How well did leading indicators forecast the South African house price deflation caused by the recent global sub-prime crisis." Thesis, Stellenbosch : Stellenbosch University, 2012. http://hdl.handle.net/10019.1/95617.

Waesch, Carsten. "Performance contrasts during the financial crisis between publicly traded family and non-family firms in Europe." reponame:Repositório Institucional do FGV, 2014. http://hdl.handle.net/10438/12073.

Machado, Fabrício Silva de Sousa. "A crise de 2008: desregulamentação, inovações e alavancagem financeira das economias capitalistas." Pontifícia Universidade Católica de São Paulo, 2017. https://tede2.pucsp.br/handle/handle/20625.

Le, Chau Ho An. "Cross-border financial linkages and international financial contagion : an empirical study of East Asia during the 2007-2011 global financial crisis." Thesis, University of Birmingham, 2013. http://etheses.bham.ac.uk//id/eprint/4455/.

Krzeminska, Anna M. "The importance of firms' strategic resources and capabilities in crisis situations." reponame:Repositório Institucional do FGV, 2015. http://hdl.handle.net/10438/14975.

Morcuende, González Alejandro. "Rupturas Urbanas. Análisis de las relaciones entre la morfología urbana y la estructura social en la Barcelona contemporánea." Doctoral thesis, Universitat de Barcelona, 2018. http://hdl.handle.net/10803/664413.

Raffaelli, Rossana Ribeiro do Prado. "A efici??ncia de mercado e a crise mundial de 2008." FECAP - Faculdade Escola de Com??rcio ??lvares Penteado, 2010.

Aguiar, Bruno César da Terra. "Predatory lending in the global financial crisis of 2007/09 : a review of the literature." Master's thesis, Instituto Superior de Economia e Gestão, 2018. http://hdl.handle.net/10400.5/17062.

Sturk, Madeleine, and Evertsson Marina Valkonen. "Reclassifications of financial intstruments in the Nordic countries : The effects of the reclassification amendments on Nordic banks financial statements of 2008 and 2009." Thesis, Jönköping University, JIBS, Accounting and Finance, 2010. http://urn.kb.se/resolve?urn=urn:nbn:se:hj:diva-12995.

Due to the apparent global economic conditions, at the end of 2008, the International Accounting Standards Board (IASB) issued amendments to IAS 39 Financial instruments: recognition and measurement and IFRS 7 Financial instruments: disclosures in October and November, 2008. The amendments allow banks to reclassify their non-derivative financial instruments in rare circumstances. This thesis investigates whether banks in the Nordic countries (Denmark, Finland, Norway, and Sweden) reclassify financial instruments, in their financial statements of 2008 and 2009.

The result of the study shows that 47% of the sample Nordic banks reclassified financial instruments in 2008 and 12% in 2009. All banks increased their net profit as a result of reclassifying financial instruments in 2008. The return on equity (ROE) increased significantly compared to whether the banks would not had reclassified their financial instruments. Tendencies found among the sample Nordic banks are that larger and less profitable banks used the possibility to reclassify financial instruments to a greater extent. Because none of the banks made losses on their choice to reclassify in 2008, the conclusion is that the opportunity given due to the amendments are mostly used by the banks to enhance the net income and the key ratio ROE. This shows that management decisions are short-term. This also indicates that the amendments may be misused by management to enhance current profit for their own benefit. The thesis also concludes that the departure from fair-value as the valuation method for financial instruments, due to recent massive critic, is unlikely.

Vachalek, Lisa M. "The Making of a Crisis in Mexico| An Inductive Analysis of Media Sentiment and Information Cascades on the Value of the Mexican Peso during the 2008 Global Financial Crisis." Thesis, University of Kansas, 2014. http://pqdtopen.proquest.com/#viewpdf?dispub=1569692.

In the two decades prior to the 2008 financial crisis, the Mexican government pursued policies aimed at liberalizing markets, while simultaneously trying to ensure the stability of the peso. These policies consisted of monetary and fiscal controls to keep inflation low and free trade agreements to reduce Mexico's dependence on the United States. The policies significantly reduced the country's public deficit and were implemented in hopes that they would help reduce the country's exposure to currency crises.

Yet, despite all provisions the Mexican government put in place, the country's peso still lost two percent of its value in the first three days following the bankruptcy of Lehman Brothers, the US-based investment firm. The loss was significant given the average appreciation of the peso in the months leading up to the crisis was one percent per month, and given that not enough time had passed to fully understand the impact that bankruptcy would have had on Mexico. By the following Monday, the peso recovered all of its lost value, suggesting that investors were uncertain about the true impact the events unfolding in the United States would have on Mexico's economy. It also suggested that the uncertainty and negative sentiment within the market during the initial week of the global crisis played a stronger role in the rapid depreciation and recovery of the peso than changes in market fundamentals.

Using an inductive analysis of the historical events, this thesis suggests the circumstances in which sentiment engendered by mainstream media and distributed through digital channels during the financial crisis could have contributed to the dramatic short-term swings in the price of the peso. Specifically, this paper focuses on the new, digital information technologies, their use among investors as a means for financial research, and the role of high-frequency trading (HFT) algorithms in initiating information cascades. HFT algorithms account for nearly 70 percent of daily trading volume in financial markets and can magnify negative market sentiment among rational investors. Utilizing historical trading data for the peso and headlines and tweets published by the Thomson Reuters news group during the crisis, I seek to illustrate the correlations between market sentiment manifest in digital media and the price movements of the peso, indicating possible herd behavior tendencies in the form of information cascades.

Though it is not possible to empirically separate the market movements of informed decision-makers from the information cascades of investors and HFT algorithms reacting to media, the fact that information cascades can and do exist as demonstrated by specific examples in this paper has significant implications for the Mexican peso. The existence of information cascades implies that having strong macroeconomic fundamentals is no longer an adequate safe guard against the immediate impacts of external crises. As social media becomes the main source of breaking news and market sentiment for mainstream media and investors, it becomes vital for emerging countries such as Mexico to monitor social platforms for sentiment related to the domestic economy in order to proactively address investor pessimism. Finally, emerging country governments can utilize these platforms to push out relevant and truthful information about the economy in order to diminish investor uncertainty and minimize the impact of externally-induced information cascades.

University of Notre Dame

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Essays on financial crises.

Macroeconomics was born as a result of one of the worst financial collapses in human history: the 1930's great depression. Since then, a rich and comprehensive literature on the causes and economic consequences of financial crises has arisen. However, despite our ever-growing understanding of extreme financial events, the evolutionary nature of the world economy implies that crises continue to occur in both, known and unknown shapes and forms. As shown by the 2008's great recession, economists and policymakers often find themselves voiceless when confronted with the unexpected outcomes of modern-day financial collapses.

This dissertation studies financial crises in emerging and developing countries. We focus on these countries because seventy-five percent of all the registered events of financial distress that occurred between 1970 and 2010, happened in these economies (Reihart and Rogoff, 2011). The chapters presented in this document, investigate the three main subjects associated with financial crises: origins, prevention, and management.

Economists have been very successful in understanding the causes and consequences of financial crises over, among others, income, trade, employment, and poverty. However, when determining policy mechanisms that allow for effective prevention and efficient management policies, results have been mixed. This dissertation contributes to the literature by proposing an innovative perspective on the prevention and management of financial crises.

Chapters 1 and 2 focus on the roots of financial crises and the formulation of optimal macroprudential policy. Specifically, we look at different scenarios in which imperfect credit markets lead to an increase in the frequency and the severity of financial collapses. We study the characteristics of the optimal policy that minimizes the occurrence of crises and restores efficiency in the market. Chapter \ref{chap:ch1} analyzes the relationship between information frictions and financial constraints. In particular, we relax the perfect information assumption in a small open economy with collateral constraints. Under such a condition, households observe income growth but do not perceive whether the underlying shocks are permanent or transitory. We find that the likelihood and severity of financial crises increase due to the interaction between the information friction and a pecuniary externality that emerges when households use an asset valued at market prices as collateral. Our results also show that the optimal tax to restore constrained efficiency is six times larger than under perfect information.

Chapter 2 provides a quantitative link between the macroeconomic relevance of overborrowing and the significance of permanent shocks to the economy. We propose an innovative approach to estimate the unobservable permanent and transitory components of income and show that as the transitory-to-permanent volatility ratio decreases, the degree of overborrowing in a decentralized economy converges to zero. Moreover, as the permanent shocks to income become more relevant to the economy, the number of crises occurring because of overborrowing falls.

In chapter 3, we turn our attention to the case of economies with highly indebted governments that are forced to reduce their Debt-to-GDP ratio in order to bring the budget under control. The chapter proposes a quantitative framework that sheds light on the optimal path that authorities can follow to achieve fiscal consolidation. We argue that the optimal design of a consolidation plan must consider the transition dynamics of the economy and maximize either welfare or another measure of prosperity. Our quantitative model explores the case of small open economies under different monetary policy regimes. We conclude that currency devaluation is a critical factor in stabilizing output during a fiscal contraction.

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