Introduction

“The classic account of financial contagions presents a standard pattern in which speculative fevers are caused by the appearance of new, unusually profitable investment opportunities”

what if one replaces “unusually profitable investment opportunities” with “subprimes” ?

Defining crises

how does a crisis work? (a) a new product appears (b) prices of the “new product” go up to unsustainable peaks (c) panic follows as investors sell assets, beginning with the “new product” (d) later passing to anything similar

Defining crises

factors fostering/preventing the spread of a crisis:capital mobilityfixed currency exchange ratesfinancial regulation

types of crises:banking crisescurrency crises

Rules and solutions to prevent or stop crises

a relation between interpreting and solving crises

needing a “lender of last resource”example: a central bank injecting

liquidity

fighting moral hazard with ruleslet the market go and learn the lesson

Rules and solutions to prevent or stop crises

solutions should consider the type of crisis and the players concerned

lender of last resource:usefull if economies involved are soliduseless if economies involved are weak

rules against moral hazard:usefull if economies involved are weakuseless if economies involved are strong

Crises propagation: interdependance vs contagion

crises may spread in two ways: (a) interdependence (b) contagion

interdependence crisis naturally spreads to markets that

are integrated

price correlation of financial products in different markets is mostly determined by this integration

Crises propagation: interdependance vs contagion

contagionrequires the involvement of loosely

integrated economies

determines a faster and broader spread of the crisis

price correlation overcomes any possible statistical distorsion

Financial crises, an historical overview

looking for contagion in the historical record, from 1637 to 1997

evidence needed isrates correlation (covariance) among

different markets, and different products: (short terms

bank loans, bonds, equities …)

seeking for the lessons learned

The first crisis: Amsterdam’s tulip mania (1636-1637)

1636-37, a “frenzy” determined by a new product: bulbs from China

no contagion, and almost no propagation

lessons learned: promoting lasting financial innovation

Two 18th century bubbles: Mississippi and South Sea

1719-20, speculation on shares of chartered joint-stock companies

financial and monetary contagion of England, France and Amsterdam

lessons learned vary:English boom of financial capitalismFrance step-back and Amsterdam

decline

The first Latin American debt crisis (1825)

1825, a crisis caused by default of (some) Latin American countries1820 Latin American bonds are more

profitable than UK obligationsa first flop on London market in 1825followed by peaks in the fixing for

unreliable countries (Peru, Chile)and a crash in 1828

The first Latin American debt crisis (1825)

evidence of no contagion: (a) correlation among various “latin bonds” only before 1825(b) correlation London stock-market index stops after 1825 drop

lessons learned, in the UK: new law on bakruptcy, and more

conservative monetary, and financial policies

Gold standard and its impact

from 1870 the gold standard emerges

currency and financial systems are more integrated than ever before

interdependence becomes thus physiological, but what about contagion?

The 1873 panic: Germany and Austria

1873, a bubble based on French war reparations to Germany:stock-market collapse in Berlin and

Vienna, plus contagion to Italy, Holland and USA, followed by a trade froze

from data no evidence of contagion possibly because gold standard was

not enforced

The first crisis in the era of the gold standard: 1890 Baring crack

spring-october 1890, a bank crisis:Argentina’s default involves London

Baring Bank and leads to a bank crisis in the USA

limited contagion (USA and Russia)a lender of last resort and

integration not yet complete lessons learned:

coordination between central banks

The 1893 USA bank crisis

1893, a bank crisis that becomes a currency crisis

a frame-work of increasing pressures on the gold standard

evidence of contagion:only in 3 out of 12 cases

shocks hit the core of the system

The 1907 panic

1907, lack of liquidity in NY market:(a) money for S.Francisco earthquake(b) UK denies the needed capitals(c) from NY the infection spreads in all

financial centres of the world

evidence of widerange contagionlessons learned:

saving gold for WW I ?

The greatest financial crisis of all (1929-1934)

before the crisis: “the five good years” (1924-1929)gold standard return

a lower degree of protectionism

remote cause of the crisisagricultural worldwide overproduction

followed by a drop in prices

The greatest financial crisis of all (1929-1934)

immediate causeoctober wall street crashes

from stock market to credit: indebtment determines a lack of

liquidity: “credit crunch”

from USA to Europea domino effect caused Europe

indebtment with USA banks

The greatest financial crisis of all (1929-1934)

effects of the crisisdefaults in payments: (i) equities

on credit, (ii) bank loans …

credit crunch

controls on capital exchange

freeze of international trade

The greatest financial crisis of all (1929-1934)

key-moments of a long-lasting crisisWall street panic, October 1929

failure of Kreditanstalt in Austria, May 1931

UK quits the gold standard, September 1931

USA dollar devaluation, May 1933

The greatest financial crisis of all (1929-1934)

a long-lasting crisis, a lender of last resort is lacking

a widespread crisis, determined by banking interdependencein a context of feeble financial integration

explains the paradox: no evidence of contagion

The greatest financial crisis of all (1929-1934)

long lasting learning from the 1929 crisis:

(1) usefulness of the lender of last resource

(2) a relation between crisis’ propagation and interdependence

The post 1929-1934 scenario

the 1930s: world is divided in trading (and financial) blockssterling area, reichsmark block,

East-Asia …

the post WW II period: controls on capital flows (IFM, World Bank), and commodity market integration

The post 1929-1934 scenario

results: a stable framework in which no global financial crises occuronly currency crises locally confined

problems: USA economic policy is constrained by its leadership

the escape: the 1971 Nixon package

The New Financial Crises

analysis of recent crises: no evidence of contagion

the underlaying thesis:

(a) interdependence not contagion

(b) crises are the “tall to pay” for enjoying the benefits of integration

(c) 1929-34 an unrepeatable crisis

The New Financial Crises

a typical pre-2008 crisis approach

after 2008, a strong revision:

(1) 1929-34 is not exceptional

(2) uneven income distribution fosters both crises

(3) 2008 is perhaps the last episode of a long lasting bubble (at least from 2001)