fincrisislecture

8/7/2019 FinCrisisLecture

1/22

The Domestic and International Political

Causes of the 2008 Global Financial Crisis

William K. Winecoff

UNC-Chapel Hill

4.18.2011

William K. Winecoff The Domestic and International Political Causes of the 2008 Global Financial Crisis 1/22
http://find/http://goback/


2/22

Why Is This Worth Talking About?

Alan Greenspan: Likely to be judged the most virulent global nancialcrisis ever.

Huh? What about the Great Depression? How could this be more

virulent than that?The U.S. lost $14 trillion , or 100% of GDP, in wealth via thestock market collapse in 2008-2009.

Fine, but it was just a U.S. crisis, right?

Nope. Global equity wealth destroyed was nearly $35 trillion ,or the combined GDP of US, EU, and Japan... worlds threelargest economies.



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Per iod

P e r c e n

t C h a n g e

2004 2005 2006 2007 2008 2009

Global Equity Markets, 20042009

S&P 500FTSEHang SengNikkei



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Ouch. That ve percentage point drop from 2008-2010 representsabout 17 million people.



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Weve lost several trillion worth of goods produced so far, and are stilllosing $800bn-$1,000bn per year. It will likely take more than a decade

to catch up, if were lucky. Double ouch.William K. Winecoff The Domestic and International Political Causes of the 2008 Global Financial Crisis 6/22


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G D P G r o w

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2001 2002 2003 2004 2005 2006 2007 2008 2009

GDP Growth, 20012009

United StatesUnited KingdomJapanChinaWorld



8/22

Who Can We Blame For This?

Scape-goating is the national pastime. But who should we put in thestocks?

Bankers : Inside Job , Wall Street 2 , Econned , etc.Bankers are always greedy bastards; cant explain changewith a static variable.

Politicians : Bush bailouts, Obama socialism, GOP toopro-business, Dems too pro-poor.Funny how everyones a socialist in a crisis, isnt it?Fannie Mae + Freddie Mac: Ownership society.

Regulators : Asleep at the wheel?

Deregulation during 1990s, with Clinton/Summers/Rubin.But weve had lots of nancial crises before, and thederegulations in 1990s dont map well onto outcomes in2000s.Crisis was international, across all kinds of regulatorystructures.



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Who Can We Blame For This?

The government appointed a blame committee The Financial CrisisInquiry Commission. What did they conclude?

The captains of nance and the public stewards of ournancial system... failed to question, understand, andmanage evolving risks (FCIC 2011, xvii).

So, same as everyone else except politicians get a pass (big surprise).

These explanations contain some truth, but theyre too easy. They

dont explain why we got the nancial crisis we got, when we got it.



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Why We Got What We Got When We Got It

The Story of Chimerica: the linkages between the U.S. and Chineseeconomies.

The U.S. had low unemployment, and wanted to consume.

China had high unemployment, and wanted to produce.U.S. policy response: tax cuts + plus cheap loans for students andsub-prime home-buyers = Ownership society + Go shopping orthe terrorists win.

China policy response: Under-valued currency + savings rates from

40-50% + state-led overinvestment in xed capital = boost employmentvia exporting.

The result:



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Remember your national accounting: Current Account - CapitalAccount = 0.

A U.S. current account decit implies a (roughly) equal capital account

surplus.I.e., China (a poor country) was sending the U.S. (a rich country)consumption goods, and nance. In exchange we gave them IOUs.Crazy?

No. Political. We want our houses and consumption goods. They want

jobs. Leaders in both countries skewed policy to meet the demands of their polities. Its about political survival, remember?



14/22


Okay. But why housing?

Macroeconomic story: CA decit > currency appreciation > increase in non-tradable goods prices relative to tradablegoods prices > shift in investment from manufacturing to

housing.Macropolitical story: Ownership society increases supply > Fannie Mae/Freddie Mac guarantee increases demand > creation and global dissemination of mortgage-backedsecurities and other exotic nancial instruments.

Not mutually exclusive of course. The result: a huge housing bubble,backed up by mountains of opaque, illiquid nancial instruments. Theselater become known as toxic assets, or, the sort of thing you dontwant to be holding when the music stops. This is what TARP bought.



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In other words, were all responsible: the citizens, the bankers, theregulators, the government, the Chinese. We all wanted the things bighouses, cheap consumer goods that the nancial sector, incentivizedby the government, provided.

But this only explains why the U.S. had a nancial crisis. How did alocal housing crisis turn into a global meltdown?



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How They Got What They Got When They Got It



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The international banking system became much more tightly integratedfrom 1999-2007.

But a disproportional percentage of holdings ended up in the U.S.

This left practically the entire world susceptible to a banking crisis in theU.S., which is exactly what happened.

As governments intervened to save their banking sectors and as taxreceipts slowed due to the decline in economic activity public debtincreased dramatically.

Interestingly enough, the world seems to have doubled-down on theU.S., and built the network back up.



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What They Got

So there is a debt crisis that threatens to break-up the Europeanmonetary union.

We get a xed investment bubble in China that threatens to pop anddrag down the worlds fastest-growing major economy.

We get a drop in Japanese growth and increase in debt, even before theearthquake and nuclear meltdown.

We get extreme commodity price volatility, which (remember Collier?)can lead to civil unrest. (Coincidence that all these revolutions arehappening in Middle East right now? Hmm.)

We get at least 23 banking crises, almost all of which happened inhighly-developed countries, around the world (according to IMFresearchers).

The collapse in global demand hurts poor workers in exporting countries.



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What We All Did

Voted out our governments (U.S., U.K., Ireland, Iceland, etc.)

Governments bailed out banks (U.S., E.U., Japan).E.U. bailed out PIGS (Portugal, Ireland, Greece, Spain is next).

Stimulus vs. austerity.



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The Lesson

Maybe Greenspan was right: maybe this was most virulent nancialcrisis ever.

Outcomes not as bad a Great Depression, because we intervened earlier.Thankfully, we learned some lessons.

But interventions are political... should we be bailing out the banks?How do we narrow decits?

Central point: the causes of the crisis, and the reactions to it, werepolitical.


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