fitzgerald global financial crisis edit

8/3/2019 Fitzgerald Global Financial Crisis Edit

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The Global Financial Crisis

and Developing CountriesValpy FitzGerald

Oxford Department ofInternational Development

UNDP HDR Course, StCatherines College, Oxford

22 September 2008


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Three FAQs1. What is happening on globalfinancial markets?

2. What does it mean fordeveloping countries?

3. What can be done from a humandevelopment perspective?


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FAQ 1

What is happening on

global financial markets?


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Origins of current financial crisis Since 1990s deregulation of financial markets: riskpricing replaces prudential supervision. Rise of

derivative assets with opaque markets and fewplayers. Bank loans replaced by bonds etc.

Huge US fiscal deficit, monetary expansion(Greenspan put), low savings led to a USmortgage boom/bust (non traded sector) and ahuge current account deficit (traded sector).

Mortgage bubbles (e.g. 1992 in UK) are familiar with

obvious political costs; join recurrent bubbles inpast decade (dotcoms, LTCM, Tequila etc); But this is by far the most serious systemically

because it threatens the global banking system itselfas creditor, and whole US electorate as debtor.


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the elephant in the room


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Sub-prime lending Sub-prime lending had spread from inner-city

areas right across the US by 2005. By then,one in five mortgages were sub-prime, andthey were particularly popular among recentimmigrants trying to buy a home for the firsttime, and the poor.

House prices were high, and it was difficult tobecome an owner-occupier. But thesemortgages had a much higher rate ofrepossession than conventional mortgages(and thus much riskier) because they wereadjustable rate mortgages (ARMs). Paymentswere fixed for two years, and then becamehigher and linked to Fed interest rates, whichalso rose substantially.


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Subprime 2

A wave of repossessions is sweepingAmerica as many of these mortgagesreset to higher rates. By late 2007, onein ten homes in Cleveland had beenrepossessed and Deutsche Bank Trust,

acting for of bondholders, was thelargest property owner in the city.

As many as two million families will beevicted from their homes as their casesmake their way through the courts. The

Bush administration is pushing theindustry to renegotiate, but mortgagecompanies are being overwhelmed bya tidal wave of cases.


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Scale and Spread

Collapse of the government backedmortgage system in the USA (Fannie andFreddie) followed by meltdown of major

investment banks (Lehman, Bear, Merrill)exposed to mortgage market

Mark-to-market asset pricing effects onbalance sheets and cumulative liquidityretraction due to rising risk aversion;

Now affecting Insurance (AIG) ; andpensions funds next?


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Global mortgage boom and bust


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The end of the stock market boom


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Financial Times, 20 Sept 2008

bank boards and bank executives havefailed to understand complex mortgage-backed banking products, as have centralbankers, regulators and credit rating

agencies. a reward system that has granted huge

bonuses to those who peddled toxic

mortgage-related products. Almost as absurd has been the degree of

leverage racked up by investment banks.


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Policy reactions

There are no atheists in foxholes and noideologues in financial crises, Mr. Bernanke told

colleagues(NYT21.09.08)

Freddie Mae and Freddie Mac (re)nationalised;

Merrill sold to BankAmerica; Lehman to Barclays;Goldman and Morgan become banks again; USgovt $700bn purchase of bad debt; G3 centralbanks support world banking.

Expansionary monetary policy (to avoid recessionlike 1930s) and scale of US Govt (and G3) bailoutswill have large repercussions, yet to be evaluated

[lessons of Mexico etc?]


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Scale of the potential bailout

(already up to $850bn)


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FAQ 2What does it mean for

developing countries?


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Growth and trade

World GDP growth already projected by IMF toslow down by 2 % points (from 5 to 3 for 2008and 09); probably more. So with 2% world

growth; global GDP per capita falls Asia probably most resilient (though exports to

US will fall); LA will slow down, Africa recession?

Commodity prices declining already; volumestoo. Natural resource exporters will be hit; foodand oil importers to benefit.


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World growth will slow, reducing

trade expansion etc.


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An end to the commodity boom?


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Investment and aid

International investment (bonds, FDI) willslow down; as will emerging marketstocks; as global confidence declines

Sovereign spreads will rise due to risingrisk premium (default probability x riskaversion): already up to 4%.

Aid flows already under pressure; will behurt by fiscal overload in G3.


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S&P 500 vs Emerging Markets Index


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Unsurprisingly, G3 market

expectations are bad


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US now HIRC?


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Recent ODA rise will be difficult to

sustain


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Poverty and human development

MDG goals even less likely to be met(growth and aid are main drivers)

Limitations of family support (Asia), few

universal benefits (LA) and narrow safetynets (Africa): effect on poor

Previous crises increased inequality,

which remains even when growth recovers Commodity price reverse will changelottery of winners and losers


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FAQ 3

What can be done from ahuman development

perspective?


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Proactive macroeconomic policy

Countercyclical monetary policy and realexchange rate management (inc. capitalcontrols) necessary:

MICs with forex reserves already do this; but LICs constrained by IMF.

Support domestic banks (esp for agriculture andSMEs), underwrite longterm investment lending;

keep real interest rates low. Raise tax pressure (notrates) to maintain fiscal

balance and reduce public borrowing.


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HD strategy for difficult times

Evidence (UNICEF) that for childrenemployment stability more important thanwages; implications for e.g. inflation policy

Essential to ringfence budgets (in real terms)for education and health; extend schemes for(simple) universal benefits.

Focus on inequality (especially horizontal)rather than just poverty; to reduce conflictand increase social cohesion.


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International action and the duty to

protect Essential to moderate G8 policy shifts (e.g.bank regulation, interest rates, exchangerates) from viewpoint of impact on world poor.

Need for UN to speak in a clear, timely andcredible fashion on these issues (TDR08 good,UN/DESA etc silent)

Regional arrangements for mutual currencysupport etc are vital (Asia progressing; LAtalking; Africa nothing). Role for sovereignwealth funds?

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